Val Wotton, Managing Director, Product Development and Strategy, Derivatives and Collateral Management at DTCC.
This year marks a decade since the collapse of Lehman Brothers, after which followed the global financial crisis. In those 10 years, regulators and policymakers have responded to the issues exposed by the crisis through the implementation of regulations to ensure greater transparency in the global financial system and the mitigation of systemic risk.
To date, in Europe, post-crisis regulation has taken the form of the European Markets Infrastructure Regulation (Emir) and the second Markets in Financial Instruments Directive (Mifid II). Further efforts by Europe to bring more transparency to financial markets and reduce risk are nearing implementation with the Securities Finance Transaction Regulation (SFTR), one component of which mandates that any transaction where securities are used to borrow cash, or vice versa, must be reported to an authorized trade repository. The new reporting requirement applies to repurchase agreements (repos), sell-buy back and buy-sell back activities; securities and commodities lending and borrowing; as well as margin lending and borrowing.
SFTR shares many similarities with both Emir and Mifid II however there are also significant differences. While different in asset class scope, SFTR is more closely aligned with Emir which covers over-the-counter (OTC) and exchange-traded derivatives (ETDs), than with Mifid II which regulates both derivatives and cash financial instruments and is focused on market abuse. Furthermore, both Emir and SFTR require reporting to an authorized trade repository supervised by the European Securities and Markets Authority (Esma) whereas Mifid II requires reporting to a National Competent Authority (NCA).
SFTR applies to both financial and non-financial entities which are either established in the European Union (EU), including all branches irrespective of location, as well as all entities that are established in a third country, where SFTR is concluded in the operations of a branch of that counterparty in the EU.
Looking specifically at the differences between the regulations, while derivatives trade reporting is now running smoothly, at the time of implementation, many market participants were not adequately prepared, which led to some delays in regulatory compliance. The securities finance industry has even more work to do in comparison to the derivatives industry when it first faced the trade reporting regulation, especially regarding data availability and the workflows that currently sit at the core of the securities finance industry. Further, repo and stock lending businesses are more siloed than those of derivatives; therefore it will likely take longer to implement processes to comply with SFTR reporting than it took for Emir. Finally, those market participants who are subject to SFTR may not have been subject to the reporting requirements of Emir or Mifid II hence they will need to start from scratch when preparing to comply.
With regards to implementation, SFTR will adopt a phased approach, likely beginning in early 2020 which means firms need to begin their preparations now to ensure that they are ready in time. We expect preparations to accelerate once the anticipated regulatory technical standards for SFTR are approved by the European Commission at the end of 2018. Indeed, in some cases, we are already starting to see a shift in gear towards planning for SFTR – several institutions are redeploying teams that until recently worked on Mifid II onto SFTR. These firms are exploring ways to access and obtain the data required to meet SFTR reporting obligations and some are considering the design and analysis of an end-to-end architectural solution.
In terms of the data that must be reported under SFTR, firms will first need to establish what data is required by examining workflows, ascertain how that data will be obtained and for that data which is not available, determine exactly how it will be sourced. Also required is validation of messages when accepting and storing them to ensure message completeness, as well as accuracy of data formats, including reference data validation, including Legal Entity Identifiers (LEIs), International Securities Identification Numbers (ISINs) and International Organization for Standardization (ISO) country codes.
Market participants who are not familiar with the derivatives trade reporting regimes may not be aware that critical to the success of SFTR implementation is the ability to report in an accurate and timely manner – reporting must occur on a T+1 basis. Further, robust control frameworks are required, including control of the data reported on behalf of firms which should be reflected fully in both books and records.
While SFTR is a European regulation, it was implemented as a result of the recommendations of the Financial Stability Board (FSB) around the reporting and transparency of securities financing transactions hence, it is likely that the regulation will be adopted across multiple G20 jurisdictions. Firms should also bear in mind that SFTR will likely apply in the UK following its departure from the EU. As a result, it is essential that market participants approach compliance with SFTR from a global perspective, including selecting a trade repository that operates globally and can ensure continued servicing of its clients in the UK as well as in the Eurozone.
Ten years on from the global financial crisis, Europe is putting in place the final strand of regulation to bring greater transparency to the financial system. Market participants need to act now to ensure readiness for the implementation of SFTR in 2020. What is more, given the interconnectedness of financial markets and the fact that a large amount of securities financing activity takes place across borders, it is essential that the regulation is seen as a multi-jurisdictional initiative aimed at reducing systemic risk on a global scale.
This article first appeared in Global Investor/FOW on July 17, 2018.
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