SFTR Out of the Shadows
In October 2011 the Financial Stability Board (FSB) set out recommendations for the shadow banking system* in a report titled Shadow Banking: Strengthening Oversight and Regulation, following a request by G20 Leaders at the November 2010 Seoul Summit. The report called for strengthening the oversight of and regulation for shadow banking, proposed approaches for monitoring, and recommended regulatory measures to address concerns. Four years later, after conferences, green papers and proposals, the Securities Financing Transactions Regulation (SFTR) was born. On 29th October 2015, the European Parliament adopted new EU rules to improve the transparency of Securities Financing Transactions (SFTs) and help supervisors and investors better understand risks.
What are SFTs?
SFTs are any transactions where securities are used to borrow cash, or vice versa. This results in a temporary change in ownership of the cash and securities which will revert at the end of the transaction in exchange for a fee. Typical examples include sale and repurchase transactions (repos), securities or commodities lending/borrowing, buy-/sell-back transactions, and collateral swaps. SFTs are used extensively by fund managers for efficient portfolio management to fulfil investment objectives or to enhance returns.
What are the aims of SFTR?
Similarly to EMIR and Dodd-Frank, SFTR seeks to increase the transparency of the SFT market by introducing transaction reporting obligations. In addition, the regulation mandates that firms publicly disclose SFT use, apply re-use conditions on collateral and apply minimum haircuts to collateral posted by non-banks in non-cleared SFTs. This will support three key aims:
- Monitor risk exposures and take better-targeted and timelier actions
- Improve transparency for investors
- Ensure that clients or counterparties have given their consent before collateral reuse can take place
On 11th March 2016, the European Securities and Markets Authority (ESMA) published draft regulatory and implementing technical standards detailing how these aims can be achieved, with a window for consultation which closed on 22 April 2016. ESMA is now considering the feedback and will publish a consultation paper in Q3. ESMA’s final report and the draft technical standards will be submitted to the European Commission for endorsement by 13th January 2017.
What should market participants be doing now?
The focus of SFTR is transaction reporting with the compliance date only days after MiFIR / MiFID II go-live. Therefore, challenges on regulatory priorities, and conflicting demands for the budget, resource, and expertise will need to be managed. These challenges can be overcome in three key ways:
- Market participants need to derive holistic requirements from the regulatory articles and perform a comprehensive impact assessment to evaluate the scale of the required change in their organisations. Robust traceability is imperative to prevent gaps and to update requirements in line with evolving regulatory technical standards.
- Given impacts are far reaching, programme governance is needed to allow senior management to oversee the universe of change activities, irrespective of whether they are being delivered by Operations, Technology or Business teams. Solution planning should consider the strategic solution, plus any transitional states required in the interim.
- The design and implementation of a flexible, sustainable operating model is necessary to effectively embed structural change, enhance customer service and maximise value. SFTR will necessitate changes to certain organisational processes, such as how collateral management is undertaken and subsequently reported. These changes could pose significant difficulties to operational efficiency and organisational controls.
In principle SFTR is an extension of current transaction reporting obligations to include SFTs; however, there are challenges that should be met head-on in 2016 to avoid any fundamental compliance issues. As market participants feel the heavy burden of regulation, there is a need to take action now to ensure that compliance with SFTR is not overshadowed by MiFID II and other forthcoming regulations.
* “credit intermediation involving entities and activities outside the regular banking system” (FSB)