The Securities Financing Transaction Regulation (SFTR) – What you need to consider
By Ben Challice, COO, Pirum Systems
Published: 27 January 2017
As part of the policies identified by the Financial Stability Board (FSB) to increase transparency across Securities Financing Transactions (SFTs), the EU introduced the Securities Finance Transaction Regulation (SFTR) which came into effect on 12th January 2016.
The regulation includes a number of new rules for market participants, including a requirement to report all SFTs to a registered Trade Repository (TR) on a T+1 basis which will begin in April 2018. The SFTS in scope include repos, margin lending transactions (including those under a Prime Brokerage agreement) stock loans, buy/sell backs and commodity loans.
The SFTR reporting obligations apply to any counterparty to an SFT that is established in the EU (including their branches, wherever they are located) or any counterparty established outside the EU transacting SFTs through an EU branch.
Where the SFT counterparty is a UCITS fund or AIF, the reporting obligation applies to its management company instead of the fund itself. The scope therefore doesn’t directly cover the AIFM but they will be expected to report on behalf on their underlying principal. However, if AIFMs utilise a non-EU fund structure, then reporting will not apply regardless of the location of establishment of the fund manager inside or outside of the EU.
The main exclusion from reporting is for transactions with EU member central banks, other Union public bodies managing public debt or the Bank for International Settlements.
Counterparties have to report details of the ‘conclusion, modification and termination’ of any SFT to a registered trade repository on a T+1 basis, and similar to EMIR, SFTR reporting will be dual-sided. This means that the ’collateral giver’ and ‘collateral taker’ (using ESMA’s proposed terminology) will be required to separately report their version of the transaction.
For example, Alternative Investment Funds (AIFs) that are in scope of the SFTR would also have to report their side of the margin loans received from their Prime Broker(s) at the fund level. An AIF trading bilateral repo with a bank would similarly require both sides to report a matching transaction to a Trade Repository including cancellations, amendments and rolls. In addition to the reporting of the SFTs, counterparties also have to report the associated collateral to the trade repository on either T+1 or Settlement date dependent on the method of collateralisation used.
The SFTR mandates the use of unique trade identifiers (UTI) so that each SFT has its own identifier, thereby enabling the regulators to pair together the separate transaction reports from both sides of the transaction. Participants must also use Legal Entity Identifiers (LEIs) to identify their counterparts along with a number of other parties involved in the SFT (e.g. Agent Lenders, CSDs, CCPs). A separate UTI and LEI is required for each fund engaging in an SFT which means the Prime Broker and the Alternative Investment Fund who takes delivery of these securities will have to report each UTI and LEI also.
The regulation also requires the reporting of both the collateral that is available for re-use as well as the collateral that has been re-used, where it is distinguishable from other assets. Where cash collateral is involved, the re-investment details must also be reported. Market participants will need to consider how they intend complying with these reporting requirements, as data on re-use eligibility and actual re-use may not be easily available or available at all in some situations.
The data ESMA is requesting includes the portfolio of assets used by the PB as collateral for any margin loans and the loan to value ratios used in their calculations. Not only are the AIFs entirely reliant on timely feeds from the PB, but often this data is only stored on the PBs systems and not replicated in the systems of the AIFs in a way they could then easily report. Furthermore, the proposed reporting of lifecycle events, creating frequent updates and modifications between trade and settlement, is also a concern for AIFs; even if they receive this data, they are unlikely to capture it.
Furthermore, there are some reportable data elements (e.g. legal agreement traded under, notice period for recall of term transaction) which market participants are not currently storing in a structured format in their existing trade booking systems. Such data elements may only be recorded in contractual documentation and therefore may not be easily accessible for direct / timely automated transaction reporting. Analysis will be required to identify any required data fields which are not easily accessible and consideration will then need to be given as to how this information will be made available to the transaction reporting process. Although the SFTR is a ‘two sided requirement’ there will actually be a great deal of one side reporting for the Prime Brokers who are in scope and the AIFMs who fall out of scope due to their jurisdiction. The PBs will however be reliant on the AIFs providing them with LEI information for example even if they are not obliged to obtain it for their own reporting.
ESMA in their second consultation paper have now amended the requirement to allow reporting of collateral to be provided on settlement date (rather than T+1) however it still has to be linked back to the original SFTs using the LEI of the counterparty with whom the collateral was exchanged and the master agreement under which it was agreed. Although they have amended their requirements, providing this information on settlement date would still present significant challenges to the industry.
Whilst the concept of transaction reporting doesn’t seem to be too complicated, once you delve into the detail, the sheer number of fields required to report the on-loan data, collateral data, margin and collateral re-use in conjunction with minimal tolerances applied to the matching fields reveals the complexity. This is likely to lead to incorrect or missing data being reported with no chance that it will ever be reconciled or matched at the repositories. By way of example. for loan and collateral data for repos, ESMA require 70+ fields, if you include margin and re use data the total number of fields increases to 90+
One advantage the securities finance market has over other market practices is the process of contract comparison, or transaction reconciliation on a real time basis throughout the day. If you already have matched positions on each side of the trade before you report, you are effectively replicating what the TRs will be looking to do when they receive the data. However, in the Security Finance value chain, Alternative Investment Funds do not widely utilise this kind of service currently.
In addition to reporting, storing the data for SFTs transactions is a concern also. ESMA mandates that loan records have to be kept for a minimum of five years and this aspect of data storage only adds to the cost of the regulatory exercise.
A key consideration for any firm in their initial assessment is to assess whether to build or buy. If you build, minor improvements to existing systems, or increasing the levels of manual work won’t be sustainable in the long term when you look at the multi-regime reporting framework spanning the globe. Deciding to buy doesn’t remove the pain entirely as you will have to contribute internal resources to evaluate requirements and ensure compliance. However, it does utilise expertise for system integrations, leverage existing infrastructure connectivity and, more often than not, save on cost.
The decision to leverage technology vendors is becoming more prevalent as many firms are assessing their delegated reporting responsibilities post EMIR and the upcoming MiFIR implementations and now have to make the decision if they want to offer this service for SFTR, especially on the sell to buy side.
Some firms have not yet started their analysis of SFTR due focus on other regulation, the implementation deadlines appearing far away (April 2018 for AIFMs) and the details not yet being completely finalised. We have seen from the two ESMA consultation papers, however, that the main points are now largely defined. SFTR poses a significant challenge to the industry with far reaching operational implications, therefore, the earlier the regulation is addressed, the more efficient and well informed decisions your organisation can make. Regulatory compliance is key to financial reputation, the right technology can give firms a competitive advantage going forward and adherence to best practice will ensure that a fund remains attractive to investors and is best placed to raise capital in the future.
Finally, if firms do opt to use a solution provider then it is important that the vendor doesn’t just solely report the transactions but will offer value add services such as reconciliation of reports, enhanced visibility of reporting lifecycle, data validation and offer data enrichment. Implementing SFTR from a technology perspective will require significant effort, so firms need to start preparing for this now as transaction reporting is here to stay.
To contact the author:
Ben Challice, COO, Pirum Systems: firstname.lastname@example.org