There is no hiding that securities financing transactions, thanks to their role in the financial crisis of 2007-2008, do not have a good reputation. The Financial Stability Board’s policy framework seeks to address SFTs’ complex and opaque nature through increased transparency of these products to allow clients a more accurate assessment of where to invest and how to decrease risks of shadow banking in the area. In the light of these promises, on 12 January 2016, the Securities Financing Transaction Regulation was published in the Official Journal of the EU. Here is how the regulation seeks to increase transparency and how – by association – it affects other instruments as well.
There is no single implementation deadline set for the SFTR. Instead, similarly to EMIR, the requirements are to be phased gradually. Record keeping and reuse conditions have applied since 12 January and 12 July 2016 respectively. Reporting rules deadlines will depend on the publication date of the technical standards, which will trigger a grace period of between 12 and 21 months depending on the type of institution. Disclosure to the client rules will need to be observed by 13 January and 13 July 2017.
The name of the regulation is somewhat deceiving. The regulation lists the instruments that are considered SFTs for its own purpose, which is not necessarily a definition that mirrors that established through market practice. Additionally, it affects other instruments. Total return swaps fall under the scope of SFTR due to the way they may be utilised in some circumstances that resemble the use of an SFT – and which instruments are affected differs for each requirement.
Since the scope is closely approaching EMIR territory, the cut-off will be derivatives contracts, which will still follow the EMIR reporting rules. Although, because the definition of a derivative contract currently does not align with market practice, it will be revised.
The breadth of firms affected is rather extensive, extending to all parties to an SFT (if they are located in the EU, or if the transaction is carried out through their EU branch) and all UCITS and AIF managers (if registered in accordance with UCITS Directive and AIM Directive, respectively). Uncertainty creeps in when considering specifically when third-country counterparties will be required to report under SFT. Hopefully, this will be clarified with the next technical standards.
Disclosure to regulator
Reporting to registered trade repositories is the key requirement introduced in the regulation. Details of each SFT concluded, modified or terminated must be reported at the latest a day after the fact by both counterparties. This should offer the national authorities a better view of who the participants are in these transactions, although it is questionable whether both counterparties to the transaction will be able to share the necessary information to the other and compile a report to the trade repository within a day of the transaction.
Exceptions to the reporting duty are given to medium-sized undertakings, non-financial counterparties which satisfy two out of three thresholds: €20,000,000 balance sheet, €40,000,000 annual net turnover or average 250 employees. UCITS and AIF managers can follow their internal structure of distribution of liability for the reporting obligations. Outsourcing of the reporting duty is possible, yet, as with other regimes, the liability for the accuracy of the information remains with the counterparty.
The data to be disclosed follows a similar pattern to that required under EMIR. Each type of instrument has three sets of information to disclose: counterparty data, transaction data, and collateral data. Despite being mostly identical, these data fields buckets are treated as separate, creating as many as 291 data fields to be reported to the trade repository. Additionally, some of the data fields are open to interpretation, especially where the information is related to collaterals. Considering that around 40% of the data fields required by other regulatory regimes broadly ask for the same information, SFTR will not only add to the general count of data that need to be reported but will also increase the duplications.
All the information about SFT that was concluded, modified or terminated must be retained for a period of 5 years, which aligns with record keeping under EMIR.
Disclosure to the investor
The regulation seeks greater transparency for the investors in two separate sets of rules. The first – the transparency requirement – is going affect only UCITS and AIF managers, who will need to disclose information about their use of SFTs and total return swaps prior to the contract, and on a periodic basis. On both occasions, the managers are required to provide the investors with different sets of data. Precontractual disclosure, which will go live on 13 July 2017, will focus more on a description of the instruments, a rationale for their use and outlines of policies and methodologies. The counterparties are compliant if the information is included in any precontractual document provided to the investor, such as a prospectus. Periodic disclosure, applicable from 13 January 2016, includes data that focuses on the features of the collateral, such as currency and maturity tenor. It must also include information that goes beyond the instrument in question, such as the 10 largest collateral issuers and the amount of collateral on loan as a proportion of total lendable assets. Although the individual pieces of information are specified, it remains unclear how detailed some of the data fields must be.
The second – disclosure to the client – requirement concerns steps that need to be taken prior to the reuse of collateral of all securities, not just SFTs. Primary formalities involve informing the providing counterparty about risks and consequences that may follow transferring a title to the collateral or granting a right to use it in a security interest collateral agreement. The providing party must expressly consent to the transfer in writing. A secondary set of instructions governs the exercise of the transfer. The reuse must be carried out in accordance with the collateral agreement and the instrument must be transferred from the account of a providing counterparty. Even though the text of the requirement is broad, it will most likely go beyond what needs to be provided under the current rules and will probably impact some types of agreement, for instance, prime brokerage agreements.
The regulation has tried to simultaneously tackle several different areas. If you sense that, instead of answering questions on shadow banking risk, the regulation has created a plethora of new questions, then your feeling is widely shared. A consultation paper, published on 30 September, highlights ESMA’s awareness of some of the issues, especially in relation to an amendment of EMIR’s technical standards. Hopefully, some of these will be answered by the Technical Standard, for which a deadline is set for 12 January 2017.