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SFTR: A new regulatory heavyweight.
At beginning of this year, most financial firms may have breathed a sigh of relief as MiFID II/MiFIR became applicable and with that, exhausting and intense projects ended without the widely anticipated “big-bang”. Following MiFID II/MiFIR, most institutions have started to optimize their new processes and allocate efforts towards digitalization strategies. However, the European regulator gives little room for those efforts as another regulatory burden lies ahead of the financial industry.
Securities Financing Transactions (SFTs) have to a large extend been exempted from transparency requirements and are soon to be subject to transaction reporting under the Securities Financing Transaction Regulation (SFTR). The new reporting regime comprises up to 153 data fields which must be transmitted to an authorized trade repository on inception, amendment, or termination of SFTs. Investment firms and credit institutions, which are first affected, can expect an application of the new requirements as of the first quarter of 2020. Given the complexity and large number of reporting information, financial institutions are well advised to act in a timely manner. In light of this, Andrea Ferrise (Regulatory Compliance Officer, London Stock Exchange Group) takes the view that the implications of SFTR should not be underestimated:
„It is quite evident that SFTR is more than a simple trade reporting practice and impacts a wide-range of investment firms in areas such as businesses processes, controls, operations, IT systems and compliance”.
Andy Dyson (CEO at International Securities Lending Association) takes it a step further and predicts:
“… there is no doubt that SFTR is a bigger deal than MiFID II, even if its exact details on transparency and reporting obligations are taking longer than expected to materialize.”
Given the weighting of these assessments, it seems worthwhile to take a closer look at the challenges as well as opportunities associated with the new regulation.
An opportunity for optimization.
Up to 153 different data fields which must be transmitted to a trade repository make SFTR a very comprehensive reporting regime. To put it in perspective, EMIR required up to 129 data fields and MiFIR’s transaction reporting contains only 65 data fields.
The consulting firm The Field Effect estimates that financial institutions as of now only have 60 percent of the required information available in their systems. This means that a huge amount of new information must be generated and new data fields and interfaces will have to be implemented. One challenge for example will be the introduction of the Unique Transaction Identifier (UTI) which will identify each transaction globally.
Another complicating factor for the implementation of the reporting requirements stems from the circumstances, that SFTs are traded in different business units depending on their primary objective (e.g. maximization of portfolio returns or usage for collateral or liquidity management purposes). Hence, banks will likely be facing a fragmented system diversity when gathering the necessary information. To name a few, collateral management systems, legal systems for information on master agreements, instrument and counterparty data as well a trading systems and market data will be relevant sources of reportable information.
Besides those challenges that have to be met, the new reporting regime offers some opportunities, too. It is recommended not to approach SFTR as an isolated reporting obligation. It should rather be built upon the existing infrastructures of EMIR and MiFIR. Integrated approaches of this nature require strategic considerations to be taken first. Those includes the selection of a suitable trade repository but also requires a strategic assessment as to how the firm should face the new requirement in general. Priority should be given to the question whether the firm should report to a trade repository itself or whether the delegation to counterparties or clearing houses is an option to consider. Such considerations should be based on a cost-benefit analysis by comparing the initial and recurring costs of implementing reporting mechanisms and the revenues gained from the usage of SFTs. This appears to be particularly relevant for non-financial counterparties that have to report for themselves and for smaller financial counterparties with less SFT trading activity.
Cause for concern for small institutes.
Estimates show that the implementation of the MiFID II/MiFIR requirements burdened the financial sector with more than 2.5 billion Euro. To ensure compliance for the next five years going forward Opimas forecasts that an additional amount of at least 700 million Euros in MiFID II/MiFIR expenses is needed. In light of this huge amount of required capital, most financial institutions’ budgets for regulatory initiatives are likely exhausted.
It is obvious that the implementation of SFTR will create an area of budgetary tension: On the one hand, financial resources are required due to follow-up costs of MiFID II/MiFIR and the realization of both, optimization and digitalization strategies. On the other hand, the implementation of SFTR will tie up large project budgets as well. Andy Dyson gives some cause for concern:
“If the cost of compliance renders securities lending uneconomic, marginal players could in effect find themselves being pushed out of the market. If this happens, it will have implications for liquidity.”
Due to the threat of high expenses required for implementing SFTR reporting, the budget related area of tension particularly could cause small financial firms to reconsider their SFT activities. Even though they can opt to delegate reporting responsibility there are still several obstacles ahead. First, they must ensure that their counterparties offer delegated reporting services, probably upon a service charge. Second, they will likely still have to transmit much of the data to their reporting counterparties to enable them to transmit both sides of the transaction.
Reporting requirements in detail.
SFTR, as an additional milestone of the recent wave of regulation, complementing the reporting and transparency requirements of EMIR and MiFID II/MiFIR. Besides provisions for the re-use of collateral and disclosure obligations for fund managers, SFTR provides comprehensive reporting requirements for SFTs, which have been exempted from reporting obligations to a large extend. Even though SFTR already entered into force in January 2016, for the reporting provision to become effective, a further delegated regulation (RTS/ITS) must be endorsed by the European Commission which has yet to happen.
The new reporting regime aims to monitor financial stability risks that arise from security financing transaction that are also widely used by the so called “shadow banking system”. Therefore, comprehensive and detailed information on conclusion, amendment and termination of SFTs have to be reported to an authorized central trade repository in the future.
Affected transaction are repurchase agreements (Repos), securities and commodities lending and borrowing transactions (LSBs), Sell/Buy-back transactions and margin lending. Furthermore, the SFTR reporting regime affects both, financial and non-financial counterparties. After the publication of the final RTS/ITS in the Official Journal of the European Union, which is expected for the first quarter of 2019, a sequential enforcement of the reporting obligation begins. Investment firms and credit institutions will be the first to comply with the regulation 12 months following the publication in the Official Journal.
Like EMIR the reporting of SFTs will be based on the ISO 20022 standard and comprises up to 153 different data fields, which can be assigned to the categories “counterparties (18 fields)”, “collateral and loan (99 fields)”, “margin (20)” and “re-use (16 fields)”. Both counterparties are required to report their side of the transaction at latest one business day after the trade was executed, whereas some special reporting constellations might occur. With subsequently cleared transactions for example both, the initial transaction and the following novation must be reported. Furthermore, if financial institutions trade SFTs with non-financial counterparties, the financial counterparty is obliged to report both sides of the transaction, if the non-financial counterparties does not exceed certain size thresholds. Financial counterparties on the other hand can only avoid reporting if they are able to delegate the obligation.
LPA as your competent partner.
LPA has been assisting banks in the implementation of regulatory obligations for more than 15 years. For the fulfillment of the new reporting requirements under SFTR, we support you with a gradual project approach which ensures an efficient implementation. We support you, starting with an impact assessment for the identification of the affected business areas, the specification of functional and technical requirements all the way to implementing the reporting mechanism, including test management. We further support you as a competent partner with selecting a suitable trade repository and the elaboration of the fundamental implementation strategy. Throughout all phases of the SFTR implementation process, we pay great attention to a resource conserving and sustainable approach and ensure that the target architecture is efficient and in line with your EMIR and MiFIR reporting structures.
Please do not hesitate to contact us!
Matthias Kirberger ist Manager bei LPA im Bereich Capital Markets & Regulation. Er unterstützt seit vielen Jahren Kunden bei der Umsetzung von regulatorischen Anforderungen im Kapitalmarktumfeld wie EMIR, MiFID II und SFTR.