While much of the post-crisis regulation has now been implemented, most recently with the implementation of MiFID II, there are still reforms that have yet to be rolled out. A good example of this is the European Securities Financing Transaction Regulation (SFTR) which is expected to go live in April 2020. The intention of this regulation is to provide regulators with greater visibility over repurchase agreements (repos) and securities lending transactions. While this is a piece of European regulation, as with MiFID II, European entities aren’t the only firms who will be impacted, but also European branches of non-European entities, or firms providing Securities Financing services to European entities. Article 15 of the SFTR has inherent extra-territorial reach due to rules that govern the re-use of instruments received under collateral arrangements with European firms. This, combined with the increasing level of market interconnectedness, means that the impact of SFTR will likely be felt far and wide.
As a result, Australian investment managers and superannuation funds should be aware that SFTR has the potential to impact them if they are interacting with European entities or European branches of non-European entities. It is important to understand that under SFTR regulation, there is an increased disclosure requirement around the existing re-use of collateral disclosure requirements. Managing this information flow could be a challenge and needs to be considered carefully. This means that beneficial owners in Australia who may loan their stock to agent lenders operating within the custodian space may also be required to consider providing disclosure information to the party reporting on their behalf. Further, given that the repo market is critical for cross-border funding – the Reserve Bank of Australia (RBA) estimates that the repo market is around A$200 billion in size, allowing large amounts of capital to flow in and out of Australia – its significance should not be underestimated.
SFTR will enable regulators to gain new insights into market exposure and associated risks across securities financing transactions (SFTs), repos (repurchase agreements for the sale of securities combined with an agreement for the seller to buy them back from the buyer at a higher price on a future date) and reverse repos (which are the same as repos except they are used to describe the other side of the repo transaction). Securities or commodity lending or borrowing transactions, margin loans used to finance the purchase of shares, and total risk return swaps are also in scope. As a result, for in-scope entities, all impacted transactions will need to be reported to a registered trade repository, in the same way that derivatives transactions are currently reported.
To move forward, funds must establish if they are in scope, and fully understand how they will work with their counterparts and service providers to ensure compliance with SFTR. SFTR will bring a number of complexities beyond existing reporting standards. For example, there are 155 data fields that are required under SFTR, nearly double that required under MiFID II. SFTR reporting also requires comprehensive identification, including a Legal Entity Identifier (LEI) and a unique transaction identifier (UTI). In addition, both sides of SFTs must be reported in a matched state, like derivatives reporting, but while derivatives are increasingly booked and defined in standardised ways, SFTs often comprise multiple positions throughout the day that are captured and booked in manual, bespoke processes. Finally, service agreements between funds and custodians may need to be revisited to clarify SFTR-related responsibilities and costs. These conversations should happen immediately to ensure all parties have ample time to prepare for next year's deadline.
Ten years on from the G20 Summit in Pittsburgh, SFTR represents one of the last pieces of post-crisis regulation to provide greater transparency in the financial markets and more specifically, in the securities financing sector. Like MiFID II, the scope of SFTR will be felt far beyond the borders of Europe, so market participants around the world must act now to ensure readiness for the implementation of SFTR in 2020.
Oliver Williams, head of repository and derivative services, Non-Japan Asia, at DTCC
