A new regulation with significant implications for securities lending is just over a year away. Lynn Strongin Dodds reports.
Just as market participants are catching their breath over the MiFID II implementation, the Securities Financing Transaction Regulation (SFTR) is looming large. While there is no set launch date yet, odds are on the first quarter of 2020. While this may seem like a long time away, any firm who has been through the regulatory wringer knows that 12 months can fly by in a flash.
It is easy to understand why the SFTR has been put on the back burner. There has been a great deal of back and forth between the European Commission and the European Securities and Markets Authority (Esma) over the finer points. As it currently stands, the Commission has endorsed 99.9% of the regulatory technical standards (RTS) but has a bone of contention with some of them.
The main stumbling blocks have been over endorsements to any changes to the Legal Entity Identifier (LEI) and the Unique Trade Identifier (UTI). In essence, the Commission believes that it should be the main authority for amendments, although this would require a change in legislation. This is why Esma argues it should have the final word, because it would be a faster process.
The result is that the SFTR is not expected to be published in the EU Official Journal until January 2019. This would leave banks with approximately 15 months to prepare. Fund managers would have roughly 21 months.
“There are distinct differences between the different players in the market,” says Paul Dobbs. managing consultant at Catalyst Development. Tier 1 players and global leading buy-side firms were first off the block conducting gap analysis studies, and many have already chosen a vendor on top of their internal processes.
“However, as you move down the scale, there are many that are so far behind that they may be in danger of struggling when the regulation goes live. Smaller firms who use an agent lender for reporting can still do so, but they will have the ultimate responsibility for what is reported on their behalf. This in itself is creating challenges between agent lenders and their clients.”
Tom Pikett, a business development manager at Trax, adds: “There have been a group of agent lenders and Tier 1 banks that are getting ready, while in the main there is another group – Tier 2 and 3 banks, as well as buy-side firms – that have only had a cursory look at SFTR. Many people have been waiting for the RTS to be endorsed, but also other things such as Brexit and CSDR [Central Securities Depositories Regulation] that are coming along the way.
“However, once published, firms will have one year to get ready for the first phase of reporting – [which] is not a long time in the world of reporting – to set-up the correct systems and processes.”
Under SFTR, market participants for the first time will have to submit their trade and collateral data at the end of T+1 and S+1, respectively, to a registered trade repository. Lessons can be learned from the European Market Infrastructure Regulation (Emir), which also uses LEIs and requires dual side reporting. However, in this case it covers not only the counterparties involved in a trade but also principal amount, currency, collateral assets, repo rate, lending fee, margin lending rate, haircut and maturity date. It also necessitates record-keeping for up to five years of any trade, following termination of the transaction.
Another key differentiator with all other regulations is the sheer volume and granularity of data that has to be reported. There are a daunting 153 data fields that need to be populated, approximately 40% of these being new. Broken down, it covers 18 counterparty data fields, 99 for transactions, 20 for margins and 16 for re-use. This compares to 129 for Emir and 85 for MiFID. Moreover, as many as 80 of those fields are required to be matched and the regulatory tolerance for any reporting discrepancies will be minimal.
A recent paper jointly published by the Depository Trust & Clearing Corporation (DTCC) and consultancy The Field Effect reveals that transaction reporting for securities financing trades may create five times as many reports as trades when the regulation is live. The paper also expects the SFTR to impact trade booking models significantly and to affect 60% of current processes, resulting in the need to develop new processes.
In addition, the new regime may create changes to sources of collateral supply within the market, which could result in the industry having to make provisions to ensure that these unintended consequences do not result in collateral supply and liquidity issues.
The challenges should not be underestimated, according to Gernot Schmidt, product manager, regulation, at SimCorp. “From a buy-side perspective, the general market consensus is that the SFTR, like Emir, will be disruptive, because the data required for the reporting is so broad. It is a very fragmented landscape and there is no natural and central point from which to access the data across the life-cycle events and collateral.”
No easy task
One of the biggest issues is the bilateral nature of the securities finance world, particularly on the repo side, which means transactions have different terms, types and percentages of collateralisation, as well as re-hypothecation of assets and complex collateral chains. As a result, gathering, enriching and collecting the data for these transactions is no easy task.
Firms are still encumbered with many disparate legacy processes, with data often siloed and stored in systems that are not related to trading technology. The securities finance industry also has much higher levels of manual processes than other product areas, which means that extracting the data is costly and time-consuming.
Not surprisingly, automation is the key, but the DTCC and Field Effect paper also recommends that firms develop a ‘reconciliation break’ strategy to ensure that efficient data management processes have been adequately reviewed.
The first step, according to Schmidt, is that market participants should look at their operating model for SFTR, their collateral management and trade life-cycle processes. “This can be seen as an opportunity for people to assess and streamline their models, not just for SFTR but for other regulations. For securities finance, though, they should ask the question, ‘do we want to take back ownership of our securities lending programmes or do we want to continue to delegate?’ In both cases, there will need to be an integrated architecture and reporting platform that collects and enriches the data as well as the pieces of underlying collateral.”
The advice is not only applicable to Europe-based organisations but also to an EU branch of a third-country counterparty. For example, if a US pension fund conducted a securities lending transaction with a Paris office of a Swiss bank, it would be in scope, even though neither the lender nor the borrower’s principal office is in the EU.
“Firms outside of Europe who operate a global programme certainly understand that their programmes need to be SFTR-compliant when dealing on behalf of a European borrower or lender,” says James Day, regional head of securities finance at BNY Mellon.
“There may be a segment of market participants that are perhaps less familiar or perhaps less comfortable with some of the requirements and they may consequently restrict their securities lending activities to the US and Asian counterparts. That said, I think the larger lenders will assist clients to comply with SFTR and all of its associated requirements.”
Although it is too early to determine how the landscape will unfold, vendors have been busy working on different solutions that remove the necessity for manually intensive intervention. The problem is how they will meet the timeframes if market participants all go for the same vendors.
“There are only a handful of key vendors providing solutions in this space and the danger is that there is a 12-month timeframe,” Day adds. “What happens if many of the institutions sign up to the same one? Will they have the capacity and ability to deliver? Will it be the case of the biggest and best first, and then the rest?”
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