Are you ready for the reporting obligations under SFTR?
In 2016, as a response to the many risks posed by shadow banking, the EU introduced the Securities Financing Transaction Regulation (“SFTR”), a set of new requirements aimed at improving the transparency of Securities Financing Transactions (“SFTs”).
Is your firm affected by SFTR?
The Regulation captures:
- EU entities that enter into SFTs (including all EU and non-EU branches), and
- third country entities concluding SFTs through an EU branch
The types of firms to be affected by SFTR include; UCITS, AIFs, Pension Funds, Central counterparties (“CCPs”), Central Securities Depositories (“CSDs”), Insurance, Reinsurance, Banks, Investment Firms and Non-Financial Counterparties.
Where the SFT counterparty is a UCITS or AIF, the reporting obligation applies to the management company or AIFM as opposed to the fund itself.
What is an SFT?
Broadly speaking, an SFT is any transaction where securities are used to borrow cash, or vice versa.
SFTs provide market participants with the opportunity to access secured funding through the temporary exchange of their collateralised assets as a guarantee. Lending or borrowing securities and commodities, repurchase (repo) or reverse repurchase transactions (reverse repo) and buy-sell back or sell-buy back transactions, including collateral and liquidity swaps are some typical examples of SFTs.
In each of the cases above, ownership of the securities temporarily changes in return for cash.
At the end of an SFT, the ownership reverts, with both counterparties being left in their original position. This will also be plus or minus a small fee (depending on the purpose of the transaction).
In this respect, SFTs act in a similar way to collateralised loans.
The SFTR introduces, among others: a) a transaction reporting obligation in respect of securities financing transactions; b) an obligation to make prescribed pre-contractual disclosures to UCITS and AIF investors in respect of SFTs and total return swaps in the UCITS/AIF prospectus and annual return, and; c) provisions for minimum transparency requirements relating to the “re-use” of collateral (financial instruments only) under financial collateral agreements.
SFTR reporting obligation
The SFTR requires both financial and non-financial market participants to report details of their SFTs to an approved EU Trade Repository (“TR”). This is in addition to any requirement to report transactions that occur under the European Market Infrastructure Regulation (“EMIR”) and MiFID/MiFIR and is part of a general move to increase transparency in the capital markets.
In order to align reporting standards to the maximum extent possible, the European Securities and Markets Authority has developed its reporting standards for SFTs building on its experience with EMIR and other EU-wide reporting regimes.
Transactions that must be reported under SFTR include, repurchase transactions, securities or commodities lending and borrowing, buy-sell back and sell-buy back transactions, margin lending transactions, collateral swaps, liquidity swaps, modifications, collateral updates and valuations, margin valuations for CCP-cleared transactions, collateral reuse and margin lending funding sources and transaction terminations and positions for CCP-cleared SFTs, if opting to report modifications and collateral updates at the position-level.
Broadly speaking, the SFTR applies to all EU financial and non-financial counterparties, including all branches irrespective of their location, as well as the EU branches of non-EU entities.
Key dates: Commencement of SFTR Reporting Obligations:
- 13th April 2020 – Investment firms and credit institutions,
- 13th July 2020 – CCPs and CSDs,
- 12th October 2020 – Other financial counterparties (this includes insurance/reinsurance undertakings, UCITS, AIFMs), and
- 11th January 2021 – Non-financial counterparties.
The SFTR overall represents another significant challenge for firms engaged in SFTs, however some of the key issues that will be faced include:
- Data Gathering/Population
There are 155 reportable fields, although the XML currently has 170-180 fields depending on the type of SFT and the XML structure is complex. Firms need to ensure for reporting purposes that they have populated all the necessary fields correctly. If one single validation rule fails, then the entire report fails.
In addition, the LEI of the issuer is mandatory for firms within the EU, or where it is an EU security.
Coupled with the above, the timeframe of T+1 is incredibly short to obtain all the data required in order to make a valid report. The validation rules are strict and have proven hard to meet. This is then compounded by the fact that as noted above, if a single validation rule fails, then the whole report fails, and the firm is likely to breach the T+1 requirement.
Whilst there is no explicit requirement in the Regulations to reconcile, there is the obligation to ensure accurate and complete reports are made, which implies that the data must be reconciled somewhere/somehow. The main issue here is that the only place that will have access to all the data likely to be needed to reconcile correctly, will be the TRs.
What should affected firms do?
Firms should look to select a TR or a third-party agent that best suits their reporting needs in terms of cost and operational efficiency. Another challenge is to analyse the SFTR’s requirements and produce an action plan for compliance based on their business and/or operations. In terms of reporting, firms should also produce sample reports based on the nature of the transactions they carry out. Once a firm fully understands the requirements and drafts its report templates, it has to develop systems to automate report generation while ensuring consistency and accuracy. This process requires careful organisation and coordination between the dealers, compliance and IT personnel.
Complying with the regulatory obligations introduced by SFTR is costly, both in terms of labour and capital. Careful planning and regulatory expertise are required to meet the challenge of analysing the SFTR’s obligations and developing the technical means and infrastructure to cope with the requirements. Furthermore, reporting to TRs entails out-of-pocket costs, and the reporting and reconciliation process has the potential to take a substantial amount of time if not automated.
Furthermore, firms should consider their internal resources and, where required, hire appropriate additional resources or utilise the services of an experienced external consultant to assist with relevant tasks. A suitable compliance advisor should be able to bridge the gap between law and practice, identify and find solutions to problems, and help affected firms dealing with shortages in resources to comply with SFTR.
In today’s financial services sector, businesses are largely driven and impacted by developments in the regulatory landscape. Financial institutions are under heightened scrutiny, and there is a need to invest significantly in compliance to protect organisations from reputational damage and costly penalties.
Given the above, there is very little time left for firms to ensure they are going to be compliant with SFTR, and firms should ensure that any areas of uncertainty are covered off in good time.