Thursday, April 28th, 2016
by GEORGE BOLLENBACHER
In the never-ending stream of market regulations coming from the EU, the one that has been overlooked, like a bear in hibernation, is the Securities Financing Transaction Regulation. Its implementation may be a little further off than MiFID II or MAR, but soon enough it will wake up and rear its ugly head. And you don’t want this hungry bear staring at you.
In the never-ending stream of market regulations coming from the EU, the one that has been overlooked, like a bear in hibernation, is the Securities Financing Transaction Regulation (SFTR), or Regulation (EU) 2015/2365. Its implementation may be a little further off than MiFID or MAR, but soon enough it will wake up and rear its ugly head.
The Scope
Article 2 of the regulation says it applies to:
“(a) a counterparty to an SFT that is established:
(i) in the Union, including all its branches irrespective of where they are located;
(ii) in a third country, if the SFT is concluded in the course of the operations of a branch in the Union of that counterparty;
“(b) management companies of undertakings for collective investment in transferable securities (UCITS) and UCITS investment companies in accordance with Directive 2009/65/EC;
“(c) managers of alternative investment funds (AIFMs) authorised in accordance with Directive 2011/61/EU;”
The tricky parts of that statement are (b) and (c), because they apply to anyone managing a UCITS or an EU alternative fund, no matter where they are located or whether they have a branch in the EU. Thus American and other non-EU asset managers (AMs) will have to comply with this regulation for any repos or securities lending done on behalf of EU mutual or alternative funds. Interestingly, the scope does not appear to include financings AMs might do for EU-based pension funds.
The scope also applies to counterparties engaging in reuse of the collateral, defined as: “The use by a receiving counterparty, in its own name and on its own account or on the account of another counterparty, including any natural person, of financial instruments received under a collateral arrangement.”
What It Requires
As we might expect, the first requirement is for reporting: “Counterparties to SFTs shall report the details of any SFT they have concluded, as well as any modification or termination thereof, to a trade repository.”
It should come as no surprise that both sides, if they are in scope, have to report the same trade. Apparently, the dismal experience that ESMA has had with the dual reporting of derivatives trades didn’t serve to warn the European Parliament or the EC not to try it again.
[Related: “Swaps Reporting Update: ESMA Gets Semi-Serious. The CFTC? Not So Much”]
Once we know that dual reporting is required, our immediate next question should be how the transaction is identified. The fact that two parties to the same derivatives trade often assign different trade IDs should have alerted folks not to make the same mistake again, but that is being left up to ESMA, which must submit draft technical standards by Jan. 13, 2017.
The mandate in the regulation says nothing about a transaction identifier, only about:
“… the principal amount; the currency; the assets used as collateral and their type, quality, and value; the method used to provide collateral; whether collateral is available for reuse; in cases where the collateral is distinguishable from other assets, whether it has been reused; any substitution of the collateral; the repurchase rate, lending fee or margin lending rate; any haircut; the value date; the maturity date; the first callable date; and the market segment.”
This is in addition to identification of the parties, including any beneficiaries.
The next question obviously will be: What happens to that information? Here, the regulation applies to the data the confidentiality provision of EMIR, which says that, “A trade repository shall ensure the confidentiality, integrity and protection of the information received.”
A Few Wrinkles
Chapter IV of the regulation addresses “Transparency Towards Investors,” and contains this language: “UCITS management companies, UCITS investment companies, and AIFMs shall inform investors on the use they make of SFTs and total return swaps.”
There is an annex that lists what information managers must provide, which includes, among other items:
“The amount of securities and commodities on loan as a proportion of total lendable assets defined as excluding cash and cash equivalents;
“Ten largest collateral issuers across all SFTs and total return swaps (break down of volumes of the collateral securities and commodities received per issuer’s name);
“Top 10 counterparties of each type of SFTs and total return swaps separately (Name of counterparty and gross volume of outstanding transactions).”
Also, extensive information about the types of collateral, the safekeeping arrangements, and the return and cost for each type of SFT.
There is also Chapter V, on the Transparency of Reuse, which includes this language:
“Where a counterparty to a collateral arrangement is established in a third country and the account of the counterparty providing the collateral is maintained in and subject to the law of a third country, the reuse shall be evidenced either by a transfer from the account of the providing counterparty or by other appropriate means.”
All clear on that? Good.
Looking It in the Face
To be sure, the biggest impact of the SFTR will fall on the unsuspecting asset manager, as it has seemed to for many EU regulations. In particular, AMs that have UCITSs along with other kinds of clients will have some of the same “mixed use” problems we see in MiFID and MAR. If that AM does large reverse repos on its cash management desk, which it then allocates to various portfolios, it will have to differentiate the portfolios subject to the SFTR from other portfolios. If its counterparty in the repo is also a reporting entity, it will have to coordinate the reporting of that portion of the transaction to a trade repository. If its counterparty isn’t subject to the SFTR, it will have to report for itself. As with EMIR, it can delegate its reporting, but it remains responsible for reporting accuracy.
Once that is ready to go, the AM has to confront the UCITS’s reporting requirement to its shareholders. Since most funds don’t have a robust technology arm, this responsibility will very likely fall on the AM. In the improbable event that a fund has more than one AM, they would have to coordinate the reporting to shareholders.
Right now, with all there is to do to get ready for MAR in July, and all the MiFID work waiting in the wings, AMs will probably put the SFTR on the back burner. But they can’t forget about it completely. You don’t want to wake up one morning to see this hungry bear staring at you.
