With the most demanding element of implementation fast approaching, asset managers captured by the Securities Financing Transaction Regulation must soon come to grips with a new, transparent, and highly detailed reporting regime.
The EU is expected to publish its final technical standards under the Securities Financing Transaction Regulation (SFTR) within the next few months, heralding a new era of transparency for the securities lending market. SFTR is designed to improve the transparency and monitoring of Securities Financing Transactions (SFTs), defined as securities lending, repurchase agreements, and margin lending.
While certain disclosure requirements are already in play, the most significant obligations under SFTR are the upcoming mandatory daily reporting of SFTs. That includes more than 150 data fields, many of which need to match promptly within established tolerances. The industry expects that the EU will adopt the final technical standards (Article 4) in Q3 2018, giving the industry just 12 months from this date to comply with the rules. This relatively short implementation timeframe means it is essential for asset managers to become familiar with the changes now and assess the impact SFTR could have on their businesses.
SFTR has a wide scope, covering any SFT counterparty established in the EU, plus their non-EU branches. SFTR also impacts non-EU SFT counterparties who transact with an in-scope counterparty, while not directly regulated, requiring them to share transaction data with the in-scope counterparty. Firms will need to report to a registered trade repository on a T+1 basis, so timing is tight. The reporting obligation is dual-sided, meaning both the borrower and lender separately report their version of the transaction.
The effect of SFTR will be felt far beyond the shores of Europe, following a recent trend of EU regulation with global effect. MiFID 2, EMIR, and GDPR, each have global impacts due to the highly interconnected nature of the investment markets today.
Asset managers are now looking to their counterparts and service providers for guidance and assistance with SFTR reporting, but the lack of clarity around legal and liability structures between market participants is a constraint. For example, the lender is the regulated entity, but they may delegate reporting to their lending agent, who may in turn use a third-party reporting service. Allocation of regulatory responsibility in this chain will be an important aspect of implementation discussions. In addition to the cost of developing a reporting platform to support SFTR, we expect approved trade repositories will charge volume-based fees to collect and submit the required SFT data. At present, it is unclear how large these fees could be.
SFTR’s roots are within the Financial Stability Board’s recommendations to improve capital market transparency and we expect SFTR is the thin end of the wedge. We expect other jurisdictions will develop their own similar reporting regimes. In the US, the Office of Financial Research (OFR) conducted a pilot data collection review in 2017 with very different requirements from SFTR, increasing the likelihood of different approaches on either side of the Atlantic. Whereas SFTR is transaction based, the OFR pilot required position level disclosure, representing a fundamental difference in approach to achieve the same desired goal. Once again, the bifurcation of regulation may result in divergent reporting requirements for similar transactions in the EU and the US. We saw a similar dynamic with the implementation of EMIR and Dodd-Frank and the disconnect they caused in the industry at the time. Lack of a global standard could result in additional cost and complexity for firms, and ultimately investors.
SFTR mandates that EU regulators review its effectiveness after a few years, provoking speculation on the inevitability of “SFTR 2.0.” Recalibration of rules after initial assessments is a global regulatory theme in recent years. Given the broad reach of the initial reporting required under SFTR, it is possible future iterations may scale back the scope of reporting data. However, for now the securities lending industry is moving forward on the prudent basis that the currently proposed technical standards will be here for some time.
Given the complexity of SFTR and relatively short timeline to comply upon adoption, asset managers and other investors would be well served to work with a specialist who can educate them on the requirements and possibly offer a delegated reporting solution.
A Vote of Confidence
Despite its challenges, many believe SFTR will yield benefits. The regulation increases confidence in securities financing and promotes greater participation to a market that already has more than $2 trillion in daily loan balances. SFTR creates better transparency by providing more real-time insight in capital markets for regulators, ultimately seeking to avoid future financial crises. And additional lending market liquidity will continue to promote strong price transparency and greater settlement efficiency.
While the European Commission has yet to adopt the Article 4 technical standards, there is activity already underway by agent lenders, borrowers, and investors to prepare for the post-SFTR way of life. And the fact that so much work is already underway speaks to the breadth, depth, and completeness of the data regulators seek to obtain. In a world of ever increasing regulatory reporting obligations, SFTR is well poised to take its place within the pantheon of big data. Asset managers should turn their gaze to SFTR now as the search for transparency reverberates throughout the industry.
This article was contributed by BBH Senior Vice President Thomas Poppey.