SFTR (Security Financing Transactions Regulation) constitutes the third limb of the EU’s sweeping regulatory reporting reforms that ensued after the 2007-2008 global financial crisis.
This overview is taken from The Financier’s book: SFTR: A Survival Guide, by Seb Malik.
The other limbs are MiFID II (MiFIR) transaction reporting – aimed at detecting market abuse and EMIR which seeks to reduce systemic risk by mandating central clearing and the posting of margin (collateral) for large classes of derivatives. A key component of EMIR is reporting trades to trade repositories.
SFTR is concerned with shining a light on the so-called ‘shadow banking’ sector ‘the scale of which is alarming…estimated to amount to close to half of the regulated banking system.’i The EU is concerned that structural reforms of the EU’s banking system ‘could result in certain activities being shifted to less-regulated areas such as the shadow banking sector.’ii
SFTs allow the build-up of leverage (the use of borrowed funds for the purchase of assets) beyond the realms of the EU’s highly regulated banking system. Whereas capital requirements and liquidity in the banking system are tightly regulated by Basel III (EU implementation = CRD IViii) which limits SFT leverage, interconnectedness and procyclicality, there is a risk that SFTs would migrate to the lighter-regulated shadow banking system.
SFTR mimics EMIR insofar as it seeks to ward off systemic risk by introducing a package of measures. As with EMIR, SFTR is far more encompassing than transaction reporting.
SFTR State of Play
As of January 2018, level II legislation – the implementing Regulatory Technical Specifications (RTS) and Implementing Technical Specifications (ITS) – remains in draft form as presented in ESMA’s 31 March 2017 Final Report. The Commission intends to adopt these measures in Q1 2018 and subsequently present the legislation to the Parliament and Council for final approval.
This book has been composed having considered all sources and provides a thorough guide to navigate the waters of SFTR.
Transaction Reporting is likely to be phased in from Q2 2019, according to entity, commencing with Investment Firms and Credit Institutions.
Pillars II and III (disclosure requirements and collateral reuse permission) are already in play.
The Commission is likely to adopt legislation in coming years, after SFT transaction reporting data is analysed, on appropriate levels of collateral haircuts (reduction applied to the value of an asset/collateral in order to account for market riskiv).
SFTR’s place in EU Financial Regulation
‘Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.’
Thus said Winston Churchill, but it could just as easily apply to SFTR. On 7 December 2017 Central Banks endorsedv remaining Basel III measures thereby drawing to a close a decade-long process of fundamental financial reform.
The voyage commenced after the 2009 G20 summit in Pittsburgh in which leaders agreed ‘to make sure our regulatory system for banks and other financial firms reins in the excesses that led to the crisis.’
The G20 also committed to reform the global architecture to meet the needs of the 21st century. They ‘established the Financial Stability Board (FSB)…’ in April 2009. ‘At the Pittsburgh Summit, the Heads of State and Government of the Group of Twenty endorsed the FSB’s original Charter of 25 September 2009 which set out the FSB’s objectives and mandate, and organisational structure The FSB has assumed a key role in promoting the reform of international financial regulation.’vi
As recitals 2-7 of SFTR acknowledge, the FSB’s reports have been instrumental in fashioning the EU’s SFTR legislation. Indeed, SFTR is the EU’s implementation of FSB recommendations (‘this Regulation follows the FSB Policy Framework’).vii The Commission’s Article 29(3) report benchmarks SFTR against them.
Having established the fundamental financial regulatory regime, the next wave of EU legislation is likely to be iterative developments on existing legislation or structures.
- CSDR (Central Securities Depositories Regulationviii) seeks to shore up CSD registration and capital and transparency requirements. CSDs provide a central point for deposition financial instruments for settlement and custodial purposes.
The Commission has proposed legislation to mitigate CCP failure risk in its: Recovery and resolution of central counterparties proposal.
Further, the EU is exploring ways to simplify and harmonise its transaction reporting regimes of MiFIR, EMIR and SFTR. The Commission is already in private consultation with NCAs to this effect.ix
Will SFTR meet its objectives? There is much skepticism. I have proffered my views on Pillar III (collateral reuse) in the relevant chapter. I believe it is window dressing. The Pillar II disclosure requirement is welcome, but I doubt it will deter investors from investing in a fund as a result of this fresh information. As for the major Pillar I Transaction Reporting, consider this fact:
60% of EU banks’ exposures to shadow banking entities are to non-EU domiciled entities.
SFTR Transaction Reporting will require global cooperation on an FSB-signatories’ level if it is to stand a chance of succeeding.
I embraced EMIR and especially MIFID II whole-heartedly. While I support the objectives of SFTR, I am more sceptical of its current form. The EU should have been far bolder in its collateral reuse rules and Transaction Reporting should have been phased in, commencing on a bilateral basis initially. This would have allowed the Commission to make necessary adjustment before phasing in the more complicated agency lending model.
Who should read this?
This book will be of special interest to:
- Heads of Legal & Compliance departments;
- Project Boards and
- Senior Business Analysts.
The casual Project Manager will also derive much benefit as this text is a distillation of the essence of complex material.
As with all regulation there is cost to be born. According to ESMA’s commissioned cost-benefit analysis, for SFT Transaction Reporting, the total one-off industry cost is between €151 – €198m. Ongoing industry costs are estimated to be €44-€59m.xi
While a majority of market participants have been broadly supportivexii of the new SFTR regime, it is not without criticism. One investment bank active in securities lending was of the view that ‘up to 80% of the required data fields possessed little economic meaning…’xiii and would thus merely create noise.
There are industry concerns over the difficulty in mapping SFT trading data to SFTR’s required data fields. Market participants expect ‘to have to make major changes to IT and data storage systems.’xiv Data will have to be drawn from disparate IT systems and matched using complex algorithms.
Firms intending to register as SFTR Trade Repositories are concerned at their ability to match over 90 fields of the two counterparties’ individual reports within strict tolerances.
Firms are concerned that under the agency lending tri-party setup, currently counterparty data is not always available by the reporting deadline of T+1.
Further, UTIs have proved problematic in EMIR and are being again mandated in SFTR. Firms need robust procedures to link transactions to UTIs.
There remains ambiguity over the meaning of certain reporting fields such as currency and what it refers to.
As for firms, upon understanding the legislation, firms should conduct impact analyses, followed by gap analyses. Solutions should be designed and presented to the project board for approval upon which functional requirements, build, testing and deployment should occur. As this book shall elucidate, SFTR will require significant cross-departmental cooperation due to the disparate data sources that need to be collated. This could serve as an opportunity to deconstruct silos and introduce a cross-departmental horizontal data workstream.
Seb Malik’s SFTR:A Survival Guide is available on Amazon from Jan 2018, published by Financier Press
i SFTR Recital 1
ii SFTR Recital 6
iii CRD IV is in fact CRD (CRD 2013/36/EU) and CRR (575/2013).
iv ESMA Leverage Report ESMA/2016/1415; p.13 at §26
v https://www.bis.org/press/p171207.htm also http://europa.eu/rapid/press-release_IP-17-5171_en.htm
vi http://www.fsb.org/about/history/; retrieved 18.11.2017.
vii SFTR Recital 7
viii Level I text: http://data.europa.eu/eli/reg/2014/909/oj; Level II technical specifications were published in the Official Journal on 10.3.2017: http://data.europa.eu/eli/reg_del/2017/392/oj
xi [ CITATION Cos17 \l 2057 ] p.25
xii [ CITATION Cos17 \l 2057 ] p.17
xiii [ CITATION Cos17 \l 2057 ] p.17
xiv [ CITATION Cos17 \l 2057 ] p.18
xv SFTR Articles 5 -12, 19; ESMA Final Report Chapter 3 p.18-33, Annexes I-V, VIII-X; Commission Delegated Regulation Ref. Ares(2017)5597698 – 16/11/2017 & separate associated Annex on fees;