Let there be light
10 December 2019
SFTR promises to shine a bright light on the dark corners of the securities finance industry but it is still unclear what regulators plan to do with the reported data, or how they will manage it
Image: Shutterstock
In the beginning, when the securities lending industry was first created, the market was a formless void and darkness covered the face of the deep. Then, in the year of regulator, 2016, the European Commission said: 鈥淟et there be light鈥�, and there was light.
And the commission called the light the Securities Financing Transactions Regulation (SFTR) and it was good.
The EC first revealed its intentions to introduce direct regulation of its securities financing transactions back in 2016, but now, with only four short months until the first wave of SFTR鈥檚 reporting requirements go live, the final picture of what the transparency initiative will actually look like is far from clear.
There are still lots of questions surrounding the data that SFTR will generate, such as: how will the regulator even begin to process it? Will firms be able to afford heavyweight technology in order to cope with producing and reporting data? Where will all of this new transaction data be stored? Is the commission likely to use this data to form even more stringent rules down the road?
The general consensus among market participants is that even those in Paris or the hallowed halls in Brussels do not truly know all the answers. It is widely understood that the European Securities and Markets Authority (ESMA) will put the market鈥檚 transaction data to use in some way, but it is as-yet unclear how.
Tim Smith, managing director, business development at Hazeltree, suggests, for example, that access to securities finance data will enable ESMA to analyse the industry in more depth and see if there is any overlap between various capital market derivative businesses.
Smith goes one step further and predicts that ESMA鈥檚 initiative is likely to be copied around the world even though SFTR already has impacts on entities outside of Europe.
Lessons from the past
The securities finance industry has seen ripples and waves of regulation over the past few years, in the aftermath of the financial crisis, from the European Market Infrastructure Regulation (EMIR) to the Markets in Financial Instruments Regulation (MiFIR), and now SFTR.
As a result, it has been argued that they also serve as a strong foundation for both the regulator and the industry to approach the formation of SFTR from a much more educated position than they did with its predecessors.
鈥淪FTR is in many ways similar to EMIR and the MiFIR reporting and all of those datasets that ESMA expected from EMIR and later from MiFIR are very similar to SFTR, albeit in a different asset class,鈥� explains Alexandra Foster, director of insurance, wealth management, financial services at BT. 鈥淓SMA has a lot of experience in dealing with data-related challenges by now, and I would hope that they will draw from the lessons learned previously to ensure smooth implementation of SFTR.鈥�
Also reflecting on previous regulations, Mark Steadman, executive director, European head, product development and change management at DTCC, stipulates: 鈥淒ata quality is now in a relatively good state for derivatives, following the implementation of EMIR and the continued rounds of changes, guidance and tightened validations under that regulation.鈥�
鈥淓SMA, for example, used the data in the trade repositories (TRs) to help set threshold limits for MiFID. For SFTR, I expect data quality to follow a quicker trajectory than EMIR as ESMA have imposed tight validations and have standardised submission formats through ISO 20022 from day one,鈥� Steadman says.
Old habits die hard
It may be true in theory that the foundations of SFTR were laid many years ago, but with the go-live just around the corner many in the industry will be getting a nasty sense of deja vu as some lessons of the past seem to have been missed.
First and foremost, as we race towards the festive break, the industry is still waiting to see the level three text that will spell out once and for all what form their SFTR reporting solutions must take. The results of market surveys on SFTR readiness and the mood and industry events paints a bleak picture of what day one of SFTR will look like next year.
Industry research, perhaps unsurprisingly, has repeatedly highlighted that the less time market participants have to complete their builds has a directly detrimental effect on the quality of data reported as testing times are sacrificed to expedite the construction process.
Compounding this trend, it was only last month that ESMA released the third draft of the SFTR, XML schemas which was found to be containing several defects that meant it was not ISO registered at that time as many were expecting.
Matt Smith, CEO of SteelEye, a London-based regtech and data analytics provider, said: 鈥淲e continuously see the regulators not really understanding important things and releasing the XML formats six months prior to go-live is not good enough. In this time, firms need to build reporting capabilities and go through thorough testing, validation and preparation.鈥�
Turning attention to past regulations, If you look at the MiFIR, one of the big issues there was around reference data, he argues.
鈥淚f the reference data isn鈥檛 ready then you鈥檙e not able to report. Although I am a big believer in the standardisation of formats, if everything was more prescriptive, including reference data, then I think the entire market would benefit,鈥� Smith added.
Are ESMA鈥檚 eyes bigger than its belly?
A further challenge ESMA has saddled itself with is the heightened need for more data to be produced and stored. David Shone, vice president, Europe, the Middle East and Africa, business solutions, policy and control at State Street, said: 鈥淭he negative aspect [of SFTR] is obviously that with more data, there will inevitably be more anomalies for ESMA to investigate.
鈥淚t should be interesting to see how they initially respond upon go-live and whether they will be more stringent than previous regulations given how much time firms have had to get this right.鈥�
Highlighting the enormity of the data ESMA is set to receive, Fabien Romero, director, SFTR, business development at IHS Markit, says that under new requirements, National Competent Authorities (NCAs) and TRs will send ESMA a vast quantity of data on a daily basis; one estimate is that up to 150 million SFTR related events may be reported on a single day.
鈥淢ultiply this by the five years of data retention required by SFTR and you can measure the enormity of the data pool available to ESMA, NCAs, TRs. To manage this, vast resources are needed to store data in clouds or data centres,鈥� Romero adds.
Reaching Nirvana
Transparency is one of the main objectives of SFTR, which SteelEye鈥檚 Smith says means that data integrity will be of the utmost importance, and the industry is working toward the standardisation of data, which is partly driven by regulation, but also by the industry itself.
Illustrating this, Martin Seagroatt, marketing director securities finance and collateral management at Broadridge, says: 鈥淥ne example is the discussion around adopting initiatives like the ISDA Common Domain Model, which represents trade events and actions in a common representation across the market.
鈥淭his standardisation harmonises data across markets which facilitates interoperability across the regulatory landscape and beyond.鈥�
Seagroatt identified that while much of the data in the financial system is already digitised, the concept of improved tools to monitor the health of markets, identify build ups of systemic risk and perform 鈥榩reventative maintenance鈥� is the same.
He explains: 鈥淩egulators could then use macroprudential levers like haircut floors or capital buffers, in addition to rate setting/access to central bank liquidity to improve the resiliency of the system in a more proactive manner than is currently possible.鈥�
This, Seagroatt says, is the nirvana state for regulators - but due to the system鈥檚 complexity we are still years away.
SFTR will require market participants to report data into as many as 153 different fields, which is something that the market has not had to deal with before.
Financial counterparties will be required to report their securities financing transactions to an approved registered EU trade repository, and structurally, it is the same as reporting under EMIR, requiring two-sided T+1 reporting model.
And the commission called the light the Securities Financing Transactions Regulation (SFTR) and it was good.
The EC first revealed its intentions to introduce direct regulation of its securities financing transactions back in 2016, but now, with only four short months until the first wave of SFTR鈥檚 reporting requirements go live, the final picture of what the transparency initiative will actually look like is far from clear.
There are still lots of questions surrounding the data that SFTR will generate, such as: how will the regulator even begin to process it? Will firms be able to afford heavyweight technology in order to cope with producing and reporting data? Where will all of this new transaction data be stored? Is the commission likely to use this data to form even more stringent rules down the road?
The general consensus among market participants is that even those in Paris or the hallowed halls in Brussels do not truly know all the answers. It is widely understood that the European Securities and Markets Authority (ESMA) will put the market鈥檚 transaction data to use in some way, but it is as-yet unclear how.
Tim Smith, managing director, business development at Hazeltree, suggests, for example, that access to securities finance data will enable ESMA to analyse the industry in more depth and see if there is any overlap between various capital market derivative businesses.
Smith goes one step further and predicts that ESMA鈥檚 initiative is likely to be copied around the world even though SFTR already has impacts on entities outside of Europe.
Lessons from the past
The securities finance industry has seen ripples and waves of regulation over the past few years, in the aftermath of the financial crisis, from the European Market Infrastructure Regulation (EMIR) to the Markets in Financial Instruments Regulation (MiFIR), and now SFTR.
As a result, it has been argued that they also serve as a strong foundation for both the regulator and the industry to approach the formation of SFTR from a much more educated position than they did with its predecessors.
鈥淪FTR is in many ways similar to EMIR and the MiFIR reporting and all of those datasets that ESMA expected from EMIR and later from MiFIR are very similar to SFTR, albeit in a different asset class,鈥� explains Alexandra Foster, director of insurance, wealth management, financial services at BT. 鈥淓SMA has a lot of experience in dealing with data-related challenges by now, and I would hope that they will draw from the lessons learned previously to ensure smooth implementation of SFTR.鈥�
Also reflecting on previous regulations, Mark Steadman, executive director, European head, product development and change management at DTCC, stipulates: 鈥淒ata quality is now in a relatively good state for derivatives, following the implementation of EMIR and the continued rounds of changes, guidance and tightened validations under that regulation.鈥�
鈥淓SMA, for example, used the data in the trade repositories (TRs) to help set threshold limits for MiFID. For SFTR, I expect data quality to follow a quicker trajectory than EMIR as ESMA have imposed tight validations and have standardised submission formats through ISO 20022 from day one,鈥� Steadman says.
Old habits die hard
It may be true in theory that the foundations of SFTR were laid many years ago, but with the go-live just around the corner many in the industry will be getting a nasty sense of deja vu as some lessons of the past seem to have been missed.
First and foremost, as we race towards the festive break, the industry is still waiting to see the level three text that will spell out once and for all what form their SFTR reporting solutions must take. The results of market surveys on SFTR readiness and the mood and industry events paints a bleak picture of what day one of SFTR will look like next year.
Industry research, perhaps unsurprisingly, has repeatedly highlighted that the less time market participants have to complete their builds has a directly detrimental effect on the quality of data reported as testing times are sacrificed to expedite the construction process.
Compounding this trend, it was only last month that ESMA released the third draft of the SFTR, XML schemas which was found to be containing several defects that meant it was not ISO registered at that time as many were expecting.
Matt Smith, CEO of SteelEye, a London-based regtech and data analytics provider, said: 鈥淲e continuously see the regulators not really understanding important things and releasing the XML formats six months prior to go-live is not good enough. In this time, firms need to build reporting capabilities and go through thorough testing, validation and preparation.鈥�
Turning attention to past regulations, If you look at the MiFIR, one of the big issues there was around reference data, he argues.
鈥淚f the reference data isn鈥檛 ready then you鈥檙e not able to report. Although I am a big believer in the standardisation of formats, if everything was more prescriptive, including reference data, then I think the entire market would benefit,鈥� Smith added.
Are ESMA鈥檚 eyes bigger than its belly?
A further challenge ESMA has saddled itself with is the heightened need for more data to be produced and stored. David Shone, vice president, Europe, the Middle East and Africa, business solutions, policy and control at State Street, said: 鈥淭he negative aspect [of SFTR] is obviously that with more data, there will inevitably be more anomalies for ESMA to investigate.
鈥淚t should be interesting to see how they initially respond upon go-live and whether they will be more stringent than previous regulations given how much time firms have had to get this right.鈥�
Highlighting the enormity of the data ESMA is set to receive, Fabien Romero, director, SFTR, business development at IHS Markit, says that under new requirements, National Competent Authorities (NCAs) and TRs will send ESMA a vast quantity of data on a daily basis; one estimate is that up to 150 million SFTR related events may be reported on a single day.
鈥淢ultiply this by the five years of data retention required by SFTR and you can measure the enormity of the data pool available to ESMA, NCAs, TRs. To manage this, vast resources are needed to store data in clouds or data centres,鈥� Romero adds.
Reaching Nirvana
Transparency is one of the main objectives of SFTR, which SteelEye鈥檚 Smith says means that data integrity will be of the utmost importance, and the industry is working toward the standardisation of data, which is partly driven by regulation, but also by the industry itself.
Illustrating this, Martin Seagroatt, marketing director securities finance and collateral management at Broadridge, says: 鈥淥ne example is the discussion around adopting initiatives like the ISDA Common Domain Model, which represents trade events and actions in a common representation across the market.
鈥淭his standardisation harmonises data across markets which facilitates interoperability across the regulatory landscape and beyond.鈥�
Seagroatt identified that while much of the data in the financial system is already digitised, the concept of improved tools to monitor the health of markets, identify build ups of systemic risk and perform 鈥榩reventative maintenance鈥� is the same.
He explains: 鈥淩egulators could then use macroprudential levers like haircut floors or capital buffers, in addition to rate setting/access to central bank liquidity to improve the resiliency of the system in a more proactive manner than is currently possible.鈥�
This, Seagroatt says, is the nirvana state for regulators - but due to the system鈥檚 complexity we are still years away.
SFTR will require market participants to report data into as many as 153 different fields, which is something that the market has not had to deal with before.
Financial counterparties will be required to report their securities financing transactions to an approved registered EU trade repository, and structurally, it is the same as reporting under EMIR, requiring two-sided T+1 reporting model.
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