The final countdown
20 March 2018
With less than a year to go, the financial services industry should be well into the preparation stages of SFTR. As the final countdown begins, industry participants speculate on the challenges and opportunities the regulation could bring
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With the Securities Financing Transactions Regulation (SFTR) implementation less than 12 months away, the financial services industry should be well into its preparation stage.
Following the recommendation by the Financial Stability Board (FSB) and European Systemic Risk Board (ESRB) to mitigate the inherent risks in shadow banking and increase transparency in the use securities lending and repo, the European Commission published SFTR in January 2016.
Securities financing transactions are any transaction where securities are used to borrow cash or vice versa.
Sejal Amin, head of membership services and events at ISLA, suggests that SFTR will fundamentally change the global securities lending market.
She says: 鈥淚n terms of the UK, what is unclear is what role the Financial Conduct Authority will play in the context of SFTR in a post-Brexit world.鈥�
Andreas Ferrise, compliance officer, UnaVista, the London Stock Exchange Group (LSEG), explains that SFTR represents a 鈥渟ignificant move towards enhanced transparency in the securities lending market and risks reduction associated with shadow banking鈥�.
However, Ferrise suggests that from a regulatory standpoint, market players will face various challenges once the regulation goes live in Q2 2019.
Ferrise notes that the collateral re-use practice could lead to complex collateral chains, especially referring to situations where there is extensive rehypothecation, meaning the same collateral will need to be reported several times.
Another situation, he suggests, could be where pools of collateral are used against multiple trades, causing difficulty allocating each element of the collateral against a specific transaction. He also explains that wila default on one transaction can cause a domino effect with other counterparties defaulting on their respective securities financing transactions if the same collateral has been used in all of these.
SFTR will require daily reporting of all securities financing transactions including securities lending transactions to ESMA as part of the financial stability mandate.
Andrew Dyson, CEO of the International Securities Lending Association, says: 鈥淲e are still waiting for the European Commission to start the formal adoption process of the draft technical standards for the SFTR that were published by ESMA in March 2017, but we expect the reporting obligation, that sits with the parties to a securities loan, to commence in mid-2019.鈥�
SFTR covers EU counterparties, non-EU branches of EU firms and EU branches of third country firms. According to Ferrise, market participants are concerned about the involvement of non-EU counterparties in the reporting chain.
Ferrise says: 鈥淭hese may be impacted when they trade in securities financing transactions, as the reporting entities will be required to obtain certain information to fulfil their reporting obligations, for instance, the legal entity identifier (LEI) of their counterparty or matching unique transaction identifiers (UTIs).鈥�
鈥淲hen SFTR transaction reporting goes live in 2019 firms will be able to report all of their securities financing transactions to UnaVista. UnaVista is already an EU-registered Trade Repository for European Market Infrastructure Regulation (EMIR) and will be extending our capabilities to cover SFTR reporting.鈥�
The UK securities lending market and the rest of the financial services industry was 鈥渃ommitted and worked very hard鈥� for the launch of the second Markets in Financial Instruments Directive (MiFID II).
Ferrise explains: 鈥淚t is evident now that market participants need to analyse the impact across firms in terms of resources and budget to be compliant in time for SFTR reporting.鈥�
鈥淐urrently, many firms are considering whether to assign additional resources for the completion of MiFID II and to begin the build-up and implementation of operational models and infrastructure for SFTR.鈥�
However, he suggests that this uncertainty may have a 鈥渄etrimental effect on the success of other projects as SFTR鈥�.
He says: 鈥淚t is quite evident by now that the SFTR is more than a simple trade reporting practice, which impacts a wide-range of financial and non-financial firms.鈥�
However, Ferrise adds that the real challenge for regulators is to ensure a high level of data quality. The industry should have already started planning and implementing all the necessary measures to tackle this mandate.
In ISLA鈥檚 recently published Securities Lending Market Report, Jo Hide, trade repository SME at REGIS-TR, explains: 鈥淭his time next year, we expect firms will be progressing well through their SFTR transaction reporting projects and gearing up to start sending the first records to trade repositories (TRs) across Europe.鈥�
鈥淎s with over-the-counter (OTC) derivatives before, this transaction reporting is a new endeavour in the securities financing and repo world, with new terminology, new workflows and, inevitably, new concerns arising as the reporting start date approaches,鈥�, Hide says.
Commenting further on SFTR, Hide cited ISO 20022 as a 鈥済reat benefit鈥� in preparation for the regulation.鈥淪o much of the data validation is contained within the format definition鈥攖he successful creation of a file already guarantees the quality of a great deal of the data you鈥檙e submitting, before it even reaches the TRs,鈥� Hide adds.
Hide concludes there are three main things that the industry can do to help make a success of SFTR. These include ensuring the unique transaction identifiers have not already been used for another trade and validating certain data against reference data lists鈥攆or example, legal entity identifier, currency codes, venue codes.
Records which pass all the checks will be submitted to the TR. For those which don鈥檛, the firm will need to correct the errors and re-submit the affected records within the
reporting deadline.
The new regulation could also bring opportunity the industry. Broadridge recently suggested that incoming regulations, such as SFTR, that require vast amounts of data generation could pave the way for the introduction of artificial intelligence.
The data that will come from compliance with SFTR could allow firms to employ artificial intelligence to 鈥渟econd guess moves by counterparties, clients and regulators and central counterparties鈥�, Broadridge predicted in a recent whitepaper.
The paper stated: 鈥淔or example, regulators may react to certain trends in the SFTR data that signal a buildup of risk by raising haircut floors or increasing capital requirements. If market participants can use artificial technology to predict better when this type of activity will occur, along with other key events such as bond market squeezes, then this can inform strategic
decision making.鈥�
鈥淭his could provide an opportunity to apply cognitive computing algorithms against SFTR and EMIR data.鈥�
Following the recommendation by the Financial Stability Board (FSB) and European Systemic Risk Board (ESRB) to mitigate the inherent risks in shadow banking and increase transparency in the use securities lending and repo, the European Commission published SFTR in January 2016.
Securities financing transactions are any transaction where securities are used to borrow cash or vice versa.
Sejal Amin, head of membership services and events at ISLA, suggests that SFTR will fundamentally change the global securities lending market.
She says: 鈥淚n terms of the UK, what is unclear is what role the Financial Conduct Authority will play in the context of SFTR in a post-Brexit world.鈥�
Andreas Ferrise, compliance officer, UnaVista, the London Stock Exchange Group (LSEG), explains that SFTR represents a 鈥渟ignificant move towards enhanced transparency in the securities lending market and risks reduction associated with shadow banking鈥�.
However, Ferrise suggests that from a regulatory standpoint, market players will face various challenges once the regulation goes live in Q2 2019.
Ferrise notes that the collateral re-use practice could lead to complex collateral chains, especially referring to situations where there is extensive rehypothecation, meaning the same collateral will need to be reported several times.
Another situation, he suggests, could be where pools of collateral are used against multiple trades, causing difficulty allocating each element of the collateral against a specific transaction. He also explains that wila default on one transaction can cause a domino effect with other counterparties defaulting on their respective securities financing transactions if the same collateral has been used in all of these.
SFTR will require daily reporting of all securities financing transactions including securities lending transactions to ESMA as part of the financial stability mandate.
Andrew Dyson, CEO of the International Securities Lending Association, says: 鈥淲e are still waiting for the European Commission to start the formal adoption process of the draft technical standards for the SFTR that were published by ESMA in March 2017, but we expect the reporting obligation, that sits with the parties to a securities loan, to commence in mid-2019.鈥�
SFTR covers EU counterparties, non-EU branches of EU firms and EU branches of third country firms. According to Ferrise, market participants are concerned about the involvement of non-EU counterparties in the reporting chain.
Ferrise says: 鈥淭hese may be impacted when they trade in securities financing transactions, as the reporting entities will be required to obtain certain information to fulfil their reporting obligations, for instance, the legal entity identifier (LEI) of their counterparty or matching unique transaction identifiers (UTIs).鈥�
鈥淲hen SFTR transaction reporting goes live in 2019 firms will be able to report all of their securities financing transactions to UnaVista. UnaVista is already an EU-registered Trade Repository for European Market Infrastructure Regulation (EMIR) and will be extending our capabilities to cover SFTR reporting.鈥�
The UK securities lending market and the rest of the financial services industry was 鈥渃ommitted and worked very hard鈥� for the launch of the second Markets in Financial Instruments Directive (MiFID II).
Ferrise explains: 鈥淚t is evident now that market participants need to analyse the impact across firms in terms of resources and budget to be compliant in time for SFTR reporting.鈥�
鈥淐urrently, many firms are considering whether to assign additional resources for the completion of MiFID II and to begin the build-up and implementation of operational models and infrastructure for SFTR.鈥�
However, he suggests that this uncertainty may have a 鈥渄etrimental effect on the success of other projects as SFTR鈥�.
He says: 鈥淚t is quite evident by now that the SFTR is more than a simple trade reporting practice, which impacts a wide-range of financial and non-financial firms.鈥�
However, Ferrise adds that the real challenge for regulators is to ensure a high level of data quality. The industry should have already started planning and implementing all the necessary measures to tackle this mandate.
In ISLA鈥檚 recently published Securities Lending Market Report, Jo Hide, trade repository SME at REGIS-TR, explains: 鈥淭his time next year, we expect firms will be progressing well through their SFTR transaction reporting projects and gearing up to start sending the first records to trade repositories (TRs) across Europe.鈥�
鈥淎s with over-the-counter (OTC) derivatives before, this transaction reporting is a new endeavour in the securities financing and repo world, with new terminology, new workflows and, inevitably, new concerns arising as the reporting start date approaches,鈥�, Hide says.
Commenting further on SFTR, Hide cited ISO 20022 as a 鈥済reat benefit鈥� in preparation for the regulation.鈥淪o much of the data validation is contained within the format definition鈥攖he successful creation of a file already guarantees the quality of a great deal of the data you鈥檙e submitting, before it even reaches the TRs,鈥� Hide adds.
Hide concludes there are three main things that the industry can do to help make a success of SFTR. These include ensuring the unique transaction identifiers have not already been used for another trade and validating certain data against reference data lists鈥攆or example, legal entity identifier, currency codes, venue codes.
Records which pass all the checks will be submitted to the TR. For those which don鈥檛, the firm will need to correct the errors and re-submit the affected records within the
reporting deadline.
The new regulation could also bring opportunity the industry. Broadridge recently suggested that incoming regulations, such as SFTR, that require vast amounts of data generation could pave the way for the introduction of artificial intelligence.
The data that will come from compliance with SFTR could allow firms to employ artificial intelligence to 鈥渟econd guess moves by counterparties, clients and regulators and central counterparties鈥�, Broadridge predicted in a recent whitepaper.
The paper stated: 鈥淔or example, regulators may react to certain trends in the SFTR data that signal a buildup of risk by raising haircut floors or increasing capital requirements. If market participants can use artificial technology to predict better when this type of activity will occur, along with other key events such as bond market squeezes, then this can inform strategic
decision making.鈥�
鈥淭his could provide an opportunity to apply cognitive computing algorithms against SFTR and EMIR data.鈥�
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