With the long-delayed implementation of the European Union’s Securities Financing Transaction Regulation (SFTR) finally looming on the horizon, those in the securities and repo markets must prepare now.
Firms have had plenty of time to prepare for SFTR: the European Commission published its proposal to regulate the reporting and transparency of securities financing transactions (SFTs) at the start of 2014 as part of its wider push to reign in on the use of securities lending and repo in shadow banking. The proposed policy called for SFTs to be reported to an EU-approved trade repository, called on management companies of UCITS and alternative investment funds (AIFS) to inform investors of their use of SFTs and included a key provision requiring collateral in these transactions to be credited to the securities account of counterparties before reuse.
The European Commission’s proposal ultimately came into force in 2016, and applies to any counterparty involved in a securities financing operation, trade repositories, UCITS investment firms and AIFMs – as well as any counterparty (including non-financial counterparties) taking part in the re-use of financial collateral. Yet despite the fact that SFTR technically came into effect more than three years ago, its implementation has been repeatedly pushed back.
Why the long delay? There’s been an ongoing spat between the European Commission and the European Securities and Markets Authority (Esma) over the regulatory technical standards (RTS) published in 2017 that must be created to identify the protocols and data around SFTs that must be reported to trade repositories as part of the regulation. Esma was initially brought in to create the standards so that overlap with existing Emir reporting requirements could be kept to a minimum.
Yet after several back-and-forths with Esma and a few minor amendments, the Commission finally agreed to the draft RTS in December 2018 – and although the European Parliament is now allowed to scrutinise the technical standards, analysts aren’t anticipating any further changes or delays. That means the new technical standards should enter into force in Q2 of 2019, with a phased go-live commencing in Q2 of 2020 for credit institutions and investment firms, followed by a phased-in approach for various other in-scope market participants like CCPs, CSDs, pension funds and more.
“The categories of in scope counterparties and SFTs are broad, and the nature of information required to be reported – much of which is subject to trade repository reconciliation – is extensive,” explains Judith Lawless, a partner at McCann FitzGerald.
“The regime is widely accepted to be complex and far-reaching, and satisfaction of the requirements will be challenging, even for those subject to other reporting regimes.”
What are the SFTR technical standards?
The primary reason the new SFTR regime is expected to be challenging relates back to the contentious RTS that were finally approved by the Commission in December – and while several consequent tweaks have been made in the interest of pushing forward implementation, the majority of Esma’s initial RTS proposals will go ahead as part of SFTR.
Those technical standards proposals range from the registration requirements for trade repositories prior to implementation, data and content that must be included as part of SFTR reporting, relevant timings, data access levels and the overall structuring of the SFTR reports themselves. ESMA’s final report on the technical standards under SFTR came in at just under 400 pages – but in the interest of highlighting key changes and points firms should be made aware of, there are several standout requirements within the RTS worth delving into.
First and foremost, the RTS has proposed to amend the existing technical standards under Emir to ensure it’s aligned with SFTR concerning the registration of trade repositories. The aligned standards will require repositories to provide information on data availability and integrity, operational separation, ancillary services, outsourcing, IT resources and a verification of reporting to Esma at the point of registration. The final RTS also mandates the use of standardised identifiers such as the Legal Entity Identifier (LEI), Unique Trade Identifier (UTI) and International Securities Identification Number (ISIN) by trade repositories.
In terms of reporting, Esma’s technical standards are grounded by the requirement to standardise SFT reporting through use of ISO 20022 and XML. As part of this reporting requirement, the market values of securities lent and the market value of associated collateral must be reported regardless of the further posting or return of excess collateral. Haircuts and margins applied in valuing collateral must be included as part of each disclosure, and in most cases daily reporting throughout the life of an SFT will be required.
Meanwhile, for margin lending Esma’s standards dictate reporting must include the lender’s funding sources – namely the requirement for position-level information from prime brokers involved as opposed to source data about transaction or an individual client.
Likewise, the reporting standards for collateral baskets under SFTR will be designed to take the technical specs of asset pools into account, and the RTS calls for the provision of position-level data for collateral wherever possible. In cases where margin financing has been secured on a net exposure against a client portfolio, parties will need to disclose the total margin financing made available and short market values.
The RTS also calls for a comprehensive data set for reporting on the reuse of collateral. Under the standards proposal, it’ll soon be required to include the type of collateral component, value and estimate reuse as part of the reporting process – alongside the reinvestment rate, reinvested cash amount and currency data. It’s worth pointing out the purchase price for a repurchase agreement won’t be considered cash collateral using the new technical standards on reporting. Instead, it needs to be reported as a principal amount in a separate field unless securities are being lent against cash collateral.
Finally, the technical standards offer extensive guidance on centrally cleared SFTs and the requirements around involving central counterparties (CCPs). Above all else, the new RTS proposal requires the collateral posted between counterparties, initial margin and variation margin to be included in all SFTR reporting. SFTR reports that include transactions involving central clearing will also need fields to identify clearing members, as well as timestamps confirming the trade registration and when the CCP takes on the transaction risk.
What amendments have been made to the RTS?
The vast majority of Esma’s draft proposals for SFTR technical standards were ultimately ratified by the European Commission in December 2018. There was a standoff that took place over much of the last year concerning who would ultimately have the ability to endorse future changes such as a global UTI mechanism of LEIs for branches – although according to Jonathan Lee of Kaizen Reporting, part of the delay in approving the technical standards just boiled down to bad timing.
“SFTR is a highly detailed and complex regulation of a market that is perhaps not widely understood,” he says.
“Much of the delay has been with the European Commission, where invariably they have been side-tracked by other regulatory agenda including CSDR and Brexit. It has been a somewhat sensitive subject, attempting to implement substantial regulatory reporting obligations on a systemically significant financial market industry for the first time.”
True enough, it's taken nearly two years for the Commission to work its way through the technical standards and offer a stamp of approval. That being said, Esma has agreed to several minor changes to the RTS moving forward into SFTR’s implementation period.
First and foremost, under the revised RTS it will be possible to include agent lenders on repo trades. There will also be a not-applicable option on termination optionality for repo and securities lending trades, and new and more substantial guidance on the UTI creation waterfall.
More important still, the timelines for trade repository reconciliations for certain fields have changed. For example, fields like security quality and type, maturity of a security, jurisdiction of the issuer and LEI of the issuer for transaction data on loans has been brought forward to Day 1. Esma’s original RTS proposal called for the Day 1 +24 months. On the flipside, certain fields under the transaction data collateral section have been pushed back from Day 1 to Day 1 +24 months.
Kaizen Reporting’s Jonathan Lee pointed out these changes were simply aimed at “smoothing out any technical difficulties in creating, submitting and reconciling files at the trade repositories” and that no further material changes to the RTS were envisaged.
“That ship has sailed,” he says.
Assuming European Parliament has no qualms with Esma’s revised technical standards, it’s widely anticipated the new standards will kick in for some market participants around the middle of 2020. Analysts are expecting Esma to publish its detailed Q+A and industry guidance on SFTR and the approved technical standards sometime in March or April 2019 – and in the meantime, McCann FitzGerald’s Judith Lawless reckons now is the time for all in-scope entities to start working on SFTR compliance, whether they’re part of the first wave for phase-in or not.
“It is completely understandable that a 2020 or later deadline may, in the context of all other regulatory compliance deadlines that financial markets participants are facing, not appear to be of immediate concern,” she says.
“However, the work required to be undertaken to facilitate compliance in respect of the broad range of in scope transactions and related life cycle events should not be underestimated.”