Mark Steadman, DTCC Executive Director, European Head of Product Development for Repository & Derivatives Services
The regulation jigsaw which was commenced following the 2008 financial crisis will come one step closer to completion this summer, with the implementation of the Securities Financing Transactions Regulation (SFTR) reporting regime. Following a three-month delay announced by the European Securities and Markets Authority (ESMA) in March due to the COVID-19 pandemic, the July 13 deadline will merge phases 1 and 2 of the regulation, covering credit institutions, investment firms, central counterparties and central securities depositories.
It is generally recognised that sell-side firms are as ready as possible for the go-live of SFTR. Although some known challenges remain — unique transaction identifier (UTI) generation and trade reconciliation being two particular areas — these issues will only be resolved through practical implementation.
The regulatory timeline presents another challenge. After SFTR goes live in July, buy-side firms will have less than three months to prepare for the next phase of the regulation, with a planned implementation date of October 11. Phase 3 brings mandatory reporting for pension funds, undertakings for collective investment in transferable securities (UCITs) and insurance firms and, in some instances, delegation of reporting. While some larger asset managers are likely to manage their SFTR reporting in-house, many firms are expected to choose a delegated reporting model that outsources reporting to the dealer community or a technology vendor. Even with outsourced reporting, SFTR specifies that the management company of a UCITs or manager of an alternative investment fund (AIF) is legally responsible for the accuracy of trades reported on their behalf, as well as obliged to ensure the implementation of effective controls for transaction reporting and data reconciliation.
The SFTR's collateral reuse reporting rules also pose challenges to delegated reporting. This is because all collateral being reused by an entity must be consolidated into a single report by the entity responsible for reporting, which creates challenges for firms who may want to delegate this task to another single party. Under SFTR, collateral reuse obligations that must be reported include the composition of the collateral, whether the collateral is available for reuse or has been reused, and the value of or estimated reuse of collateral. This degree of collateral reuse reporting is a significant operational undertaking for buy-side firms, especially firms that may not be as far along in their preparations as they should be.
Delegated reporting is also complicated by the diversity of products that are in-scope of SFTR and their subsequent different trading flows. Accessing the data from the trade repositories after it has been reported may prove challenging, for instance, in cases where the UCITS or AIF manager has outsourced management of part or all of the fund to another fund manager responsible for the day-to-day investments and trades, who then delegates reporting to another party. The fund manager will not be identified on the trade, creating difficulties when applying controls to ensure reporting compliance has been met.
Preparation for phase 3 buy-side deadline
As sell-side firms count down the last few weeks to the implementation of phases 1 and 2 of SFTR and make final adjustments to their systems, they should ensure they take into consideration the phase 3 deadline for the buy side.
During this run up, buy-side firms should be preparing for phase 3 by selecting their trade repository, finalising reporting plans and prioritising testing to avoid operational disruption. The regulatory reporting function is extremely complex, given the diversity of securities finance transaction (SFT) products and the level of detail SFTR requires. As a result, firms could face significant risk of noncompliance both from a reputational perspective and financially, if due diligence is not undertaken.
One SFTR requirement that may cause significant challenges is the requirement to convert firms' internal SFT data to the ISO 20022 XML format, especially given the high number of data reporting fields under SFTR. In most cases, the introduction of ISO 20022 will require firms to translate data from different internal systems to generate a submission message that meets the XML schema and regulatory validations. It is generally accepted by the industry and the regulator that the schema will be updated once the dust has settled after go-live, most likely in 2021. Furthermore, as was the case with the European Market Infrastructure Regulation (EMIR), it is expected that there will be further tweaking of the regulation once regulators have had a chance to consult and review the data.
This article was originally published in Thomson Reuters Regulatory Intelligence.