This year, as part of wider global regulatory efforts to provide greater transparency into market-based financing activities, often referred to as “shadow banking,” the EU is implementing the Securities Financing Transactions Regulation (SFTR).
SFTR is designed to improve transparency and monitoring of Securities Financing Transactions (SFTs), which includes activities such as securities lending, repurchase and reverse repurchase agreements (repos), and any sell/buy-back transactions involving securities or commodities.
The measures proposed are similar to the European Market Infrastructure Regulation (EMIR) adopted in 2012, which introduced mandatory reporting for derivative transactions. Many industry participants struggled with the EMIR implementation and it is hoped that lessons learned will lead to a smoother implementation for SFTR. As with EMIR, responsibility for satisfying the requirements of the regulation rests with the principals to the transactions, e.g. principal lender and principal borrower in a securities lending or repo transaction.
IMPLEMENTATION: A PHASED APPROACH
SFTR is being implemented in phases, starting in January, UCITS and Alternative Investment Funds (AIFs) were required to start disclosing data around SFTs in all fund financial statements Then in June, asset managers will be required to disclose their permitted SFT trading activity in their fund prospectuses.
While most asset managers have begun preparations for these requirements, SFTR’s most significant and complex phase begins with the implementation of Article 4 which introduces the mandatory reporting of individual SFTs. The European Securities and Markets Authority (ESMA) released its final technical specifications in March The technical details are expected to be published to the Official Journal of the EU at the end of this year. The industry will have one year from this date to comply, making the probable start date Q4 2018.
Based on the draft reporting requirements, a significant level of detail will be required at the individual transaction level. All transactions must be reported to an EU-registered trade repository within one working day (T+1). Similar to EMIR, all transactions also have to be reported separately by both parties to that transaction and certain data fields must match in order for the transaction to be successfully reported. UCITS and AIFs are not formally required to report until a subsequent phase some months later. However, typical UCITS and AIF trading counterparties must begin reporting from the initial implementation date. Given the dual sided reporting requirement, Q4 2018 is being viewed as the de facto live date for all parties.
DATA AND REPORTING CHALLENGES
Based on the draft technical specifications, the scope of required data fields is expansive. While all necessary data is readily available to one or both parties to the trade, not all of the required data is typically stored at the transaction level. For example, the jurisdiction and type of legal contract governing the transaction is not data typically stored at transaction level but must be reported per transaction under the new rules starting in 2018. The draft technical specifications also require that approximately 60 data fields be matched within very tight, or zero, tolerances. This is approximately six times the number of fields required to match under EMIR.
To ensure the required data is readily available, managers will need to make changes to their current operational and reporting systems. ESMA finalized the technical specifications on 31 March and industry participants now need to move quickly to assess solutions. Components such as the need to report changes to collateralization throughout the life cycle of the SFT, and agreement between counterparties on unique transaction identifiers will be onerous and complex. ESMA has proposed that trade details must be retained for at least 10 years, which is generally longer than standard record retention requirements under other regulations.
A unique aspect of the reporting requirements is that they apply to EU and third-country counterparties if the SFT is transacted through an EU branch of that third country counterparty. For example, a stock loan between a Japanese pension fund and the London branch of a Swiss bank would be included in the scope of the regulation because one party to the trade is an EU branch even though neither the lender nor the borrower’s principal office is in the EU.
UNDERSTANDING THE FULL SCOPE
Many industry participants are concerned that the data requirements are too detailed with many fields serving no obvious purpose.
Principals to SFTs must engage in 2017 to develop solutions for satisfying these complex filing requirements. Firms committed to satisfying them will need to conduct the classic build, buy, or outsource assessment. A year may appear to be enough time to finalize solutions but lessons learned from EMIR suggest otherwise. It would be foolish to underestimate the technical and stakeholder coordination challenges inherent in satisfying a detailed, dual-sided, reporting regime such as SFTR.
SFTR IMPLEMENTATION PHASES
Part of this article was originally published in the 2017 Regulatory Field Guide. The guide features insights from a number of our experts on important regulatory developments for asset managers in the year ahead. Visit bbh.com/regulatoryfieldguide to explore the guide.