Challenges are on the horizon for firms subject to the Securities Financing Transactions Regulation enforced through the European Commission. The Securities Financing Transactions Regulation, or SFTR, was announced back in 2014 and entered into force on 12 January 2016. It is geared to be fully implemented by 2019 with the last phase in occurring during quarter three and is likely to pose a few challenges for firms during the lead up and thereafter. The regulation will require firms established in the European Union and non-EU branches to report securities financing transactions, or STFs, to trade repositories with the main goal being to increase transparency in the securities financing transaction market.
Who, what and why?
The securities financing transactions market is a sector which is not currently monitored by other regulations, hence why the European Commission needed to fill the void. SFTR was established in an effort to increase transparency in the securities financing transactions market and will require firms to report all of their securities financing transactions to an EU trade repository. Another goal of SFTR is to reduce the reuse of financial assets received as collateral under collateral arrangements by setting limitations or conditions that must apply. Collateral arrangements are security financial collateral arrangements or a title transfer financial collateral arrangement, in each case, as defined in the Financial Collateral Directive. SFTR expands the definition of reusing to also include the transfer of securities under a title transfer. A by-product of the new requirement is the suggestion of a standardised reporting format that will make it easy for errors to be identified early on and provide a resource for comparing transactions. The new regulation will apply to any European Union counterparty and third-country counterparties only if securities financing transactions are included in the operations of an EU branch of that counterparty.
Reporting, recordkeeping and reusing
Key issues the Securities Financing Transactions Regulation covers are the obligation to report and the record keeping process. SFTR states that counterparties to SFTs need to report the details of future, and modifications or terminations of past, securities financing transactions to an EU trade repository within one working day. A phase-in approach is being used for the implementation of Article 4- Obligation to report, and will occur from the end of 2018 staggered through to the end of 2019. For EU and third-country investment firms and credit institutions, the regulation will apply from May 2018. The reporting obligation for EU and third-country CCPs and CSDs will apply from August 2018 and for financial counterparties and third-country entities, November 2018. The last implementation date is February 2019 and applies to the reporting obligation for non-financial counterparties. As part of the reporting process, firms will be required to store information regarding any securities financial transaction that they conclude in the future, and modify or terminate from the past, for at least five years, though it is recommended that they keep the records for ten years. This record keeping requirement is not affected by the postponement of the SFTR’s implementation, so it is imperative that counterparties subject to the SFTR have the necessary processes in place to comply with this initiative or they risk breaching the regulatory requirements.
The reusing portion of Securities Financing Transaction Regulation states that, if a counterparty is interested in reusing financial assets gained as collateral, they must fulfil at least one of the following conditions. The first being that, “the providing counterparty has been duly informed in writing by the receiving counterparty of the risks and consequences that may be involved in one of the following: granting consent to a right of use of collateral provided under a security collateral arrangement and concluding a title transfer collateral arrangement.”, and the second: “the providing counterparty has granted its prior express consent, as evidenced by a signature, in writing or in a legally equivalent manner, of the providing counterparty to a security collateral arrangement or has expressly agreed to provide collateral by way of a title transfer collateral arrangement.”
Upcoming challenges and changes
The requirement of firms to report all of their SFTs to a European Union trade repository may create operational challenges in the trade data generation and submission areas. Additionally, it may lead to changes in the international accounting practices in an effort to identify STFs accordingly. Regarding the reduction of reusing collaterals, participants will need to establish whether the transactions fall within the conditions. This change could be problematic as it might result in a collateral chain reaction that starts off with a default in one transaction and results in all other counterparties failing to meet legal obligations of their transactions. SFTR also introduces minimum standards for how collateral is valued which would remove the possibility of securities financing transactions being used to expose the weaknesses in financial balance sheets. Lastly, firms will have to consider how to monitor the new transactions and how the documentation of transactions needs to be adjusted in order to comply with the new regulation.
The SFTR, or Securities Financing Transaction Regulation, is nearing the end stages of its implementation, with only the individual reporting dates left. This new regulation is an attempt to monitor and prevent financial institutions from partaking in risky transactions that could endanger the market and to increase the transparency of the securities Financing transactions markets. By the third quarter of 2019, all counterparties related to SFTs will need to comply with the reporting and record keeping requirements as well as the new guidelines for reusing collateral.