SFTR – Not just another EMIR

As we enter 2018, much of the Capital Market’s regulatory focus is concentrated on the early days of MiFID II. The Securities Financing Transactions Regulation (SFTR) appears to have fallen off the industry’s radar, seemingly dismissed as EMIR’s younger sibling. However, there is much more to it than that, and failure to comply could mean significant regulatory fines. I’m of the opinion that, despite the challenges, SFTR represents an opportunity for firms to gain a competitive edge with strategic use of new data capabilities.

Consistent with the regulatory drive for greater transparency in financial services, SFTR includes the latest transaction reporting regulation that looks to shine a light into the industry’s murkiest corners. Where EMIR captures derivatives and MiFID II looks at a broader set of asset classes, SFTR will concentrate on repurchase agreements (repos), securities lending activities, margin lending and commodities lending. With an expected reporting go-live of Q2 2019, there is little time left to understand and comply with the regulation.

The challenges ahead

In addition to the time pressure and operational challenges that accompany the introduction of any transaction reporting regulation, SFTR’s reporting requirements are complex and will require extensive effort to understand and operationalise. Four key areas that I think will prove challenging are:

1. Territoriality: SFTR reporting will be at a branch level, rather than a head office level like EMIR (although LEI codes will still be used as identifiers). The regulation will therefore cover EU counterparties, non-EU branches of EU firms and EU branches of third country firms. Although the draft technical standards contain detailed information on when each counterparty is obliged to report, the industry has traditionally struggled to interpret and apply these rules successfully, particularly when non-EU entities are in scope.
2. Collateral reporting: The reporting obligation for SFTs does not just cover the inception of the transaction, but also any of 11 trade lifecycle events, one of which is collateral reuse. This could create two challenges: firstly, where there is extensive rehypothecation the same collateral will need to be reported multiple times; on the other hand, where pools of collateral are used against multiple trades, there will be difficulty allocating each element of that collateral against a specific transaction.
3. Dual-sided reporting: Under SFTR, depending on the jurisdiction and size of the counterparty, multiple counterparties to a transaction may have an obligation to report. This will prove especially challenging for smaller firms and non-financial firms who may not have the infrastructure to report SFTs. Although delegated reporting is mandated for the smallest firms, as with EMIR it may be prudent for banks to provide delegated reporting services to their larger clients to avoid data reconciliation issues down the line.
4. Trade Repository matching and reconciliation: Post-trade reconciliation was a huge problem after the EMIR go-live, with less than 40% of trades reported as matching by the DTCC in March 2014. However, this was a result of insufficient guidance on the use of Unique Trade Identifiers, which SFTR goes some way towards addressing. There are still 153 data points that need to be reported to trade repositories under SFTR, of which 82 need to be an exact match between counterparties when compared by trade repositories.

As with any cloud, there is a silver lining: with much of the reporting data required by the regulation not currently being collated, the shrewder counterparties will be able to use this new data pool to gain insight into their Securities Financing activities.

Actions firms should be taking

Considering the complexity of the reporting, combined with the operational difficulties of implementing the regulation, there are several things that I believe counterparties should be doing to be compliant by Q2 2019:

1. Complexity and interpretation:. Firms need to completely understand their regulatory responsibilities for SFTR. Whilst there is some guidance on when firms will be required to report trades, requirements will need to be tailored according to the type of trade, the origin of the trade, and the required timeliness of submission to the Trade Repository.
2. Utilise previous experience and new technology: This is not the first Transaction Reporting Regulation, and it will not be the last. Counterparties should leverage previous lessons learned, especially from EMIR. They should also be assessing their trade and reporting data, and understanding if the extraction and reporting methods are efficient and accurate. Their reporting infrastructure should be scalable with the flexibility to accommodate more reporting requirements as further regulations may necessitate. With a multitude of technology solutions available, in addition to strategic partnerships between trading platforms and trade repositories, firms must ensure their reporting is in line with industry standards.
3. Strategic thinking: In my opinion, firms should look to capitalise on the opportunities presented by SFTR. Although the idea is still in its infancy, firms could use their new found SFT data to enable strategic decision making. If firms can recognise where trends in data may trigger a response from clients, counterparties or the regulator, the subsequent counter-activity may be pre-empted, so firms could mitigate or even prevent any resulting adverse effects.

Summary

Whilst SFTR is similar to its predecessors, I believe counterparties should not underestimate the challenges that it will bring. There is now an opportunity to reflect on past mistakes, utilise new technology and enhance data analytics to earn a competitive edge in the market. To successfully achieve this, SFTR must be firmly in the Book of Work for 2018.