Time to mobilise
20 June 2018
Andy Dyson, chief executive of ISLA, discusses its preparations for SFTR and what to expect from the association’s conference in Lisbon
Image: Shutterstock
What is ISLA working on at the moment?
First, is the extensive work that we are doing on the development of a new market standard agreement that will allow participants to move collateral onto a pledge rather than title-transfer basis, which is a new market wide agreement that is sitting alongside our other market standard agreements. And, that should be finalised in the next couple of weeks, ahead of our conference in Lisbon.
Secondly, there is work going on in regards with preparing for Securities Financing Transactions Regulation (SFTR). We are also carrying out background work on the UCITS landscape and their relative competitive position, and so when it comes to lending, we will be doing a lot of work there regarding regulators and policy makers trying to paint a picture around how UCITS should perhaps have a slightly bigger footprint when it comes to lending across European markets. Particularly so in the context of the Capital Markets Union (CMU) that will become more prevalent in a post-Brexit world. Those are the things that I would highlight at a top level.
Other things that we have been working on are our events, in particular our up and coming main conference in Lisbon, which is taking up quite a lot of resource at the moment.
How is ISLA preparing for SFTR?
SFTR is probably the single most important and wide-ranging reporting obligation that our market has ever seen, certainly in Europe, and it has its origins in the post-crisis regulatory agenda set by the Financial Stability Board (FSB) and particularly by the FSB workstream 5.
The SFTR covers: securities lending, repo, prime brokerage, and financing activities across Europe with a daily reporting requirement, our main focus is securities financing.
At the moment, we are still waiting for the European Commission to start the formal adoption process of the Technical Standards that were published by European Securities and Markets Authority (ESMA) in March 2017.
However, we feel that it is important for the industry to begin to mobilise and think about compliance because there is an awful lot to do once the commission fires the starting gun around implementation. In this pre-implementation phase, we will be looking closely at their Technical Standards when they are published by the commission to ensure that they are consistent with the draft Technical Standards that were published by ESMA last year.
Meanwhile, alongside other firms and industry stakeholders, we are beginning to take a detailed look at two very important issues. The first one is data, and the second revolves around the generation of unique transaction identifiers (UTIs). Taking data first, there are 97 data points in a securities lending transaction that are required to be reported on a daily basis. Lenders have to furnish all 97 data reporting points as part of the dual rating reporting regime. Borrowers also have a similar obligation but around about a quarter, approximately 24/25 fields that the borrowers have to report they can only get from the lenders.
There is a high level of market dependency between the two, and to facilitate a better understanding of these data points we have published an initial data dictionary that looks at the relative responsibility for each of the data points in the reporting regime, both loans and collateral and highlights where that data should come from, namely from either a lender, borrower or potentially elsewhere, such as a tri-party agent.
We have also identified how easy or hard we think those data points are in terms of accessibility and interpretation. We have data points that are green and would appear to present no material issues to market participants. We have two further categories that are amber and red. The amber ones need further work to agree to a common approach across the industry, and the third red group would appear to presents significant challenges to members.
My objective, as chief executive of ISLA, is to get a common understanding around the data points and a common interpretation across the industry, so that everybody is starting from the same point.
I do not have a real interest, and nor should I, in whether firms decide to use one particular commercial offering or another. Our main focus is to get everybody to the same starting point around understanding and we think that’s critically important, and we have so far received strong support from all elements of the industry to do that. We will continue with that work during the summer.
You recently said that SFTR is at “a very pivotal point”. What developments have there been since then?
In addition to data, we have started work around UTIs, which are the link in the chain when the trades are reported to trade repositories. We have issued guidance about market best practices and have suggested how the industry can do a better job of UTI generation. There is still some work to be done. It is not a finished article yet. An industry-wide approach around UTI’s will have considerable benefit to all concerned.
We have known for some time that a lot of loans come from lenders who are outside of Europe. About 60 percent of outstanding loans come from lenders outside of Europe, who themselves don’t have a reporting obligation under SFTR, but they do have a requirement to provide certain details of their loans to the borrowers who do have a reporting obligation. That dynamic is now raising some interesting questions from those communities outside of Europe about the need to do this, their willingness to do this, and the cost involved. Therefore, there is more to come in terms of what to talk about in that space.
How can firms ensure they approach SFTR correctly?
SFTR itself is a large, unyielding, and fairly difficult reporting obligation. I would not underestimate the amount of work needed to make this happen. But I also think that if firms think about it in a slightly broader way then this could be a great opportunity to address data flows, information flows, data aggregation and collection within their firms, and sweep away some of the legacy systems and processes we have seen in the past.Therefore, it is a great opportunity. There is a strong link to one of my favourite topics, which is agent lender disclosure (ALD). The market should use the mandatory requirements of SFTR as a springboard to re-examine the continued sustainability of ALD. In the long term, the two cannot co-exist because it does not make sense practically and economically to have the two operating in our market. The market needs to spend some time thinking a bit more about that.
Aside from dealing with data, what other trends are you currently seeing in the securities lending space?
We continue to see a market that is still very much split between debt and equities, the equity market has always been a big component of our industry. In the last couple of years, we have seen the rise of government bond lending and HQLA assets, and that trend continues. Therefore, we see securities lending becoming an equity pump for the broader capital markets. One of the factors that we are seeing in particular is to comply with much of the regulation that we have before us. Last week’s commission published a draft outlining their final technical standards on Central Securities Depository Regulation (CSDR)—the settlement discipline regime. To comply with all of this, you need to be a pretty large organisation to absorb all of these costs.
This means that having scale and significant size now appears to be an important factor in whether or not you’re successful in this market. That does not mean to say that you can’t be successful if you are small but I think it is more difficult. And that is completely out of line with what the commission would want here.
Regulators would generally like the markets to be full with people carrying out lots of things so that everybody has lots of choice. They like that in consumer markets and they like it in financial markets. But the burden of reporting that we’ve seen—particularly around financial services and our markets—means that increasingly firms just can’t actually absorb these costs. This is an important trend that we are beginning to see play out in the discussions that we are having. Lastly, the other big trend is the general drift towards passive asset management away from active asset management. This includes the rise of index funds.
Consequently, if you are managing to an index then securities lending becomes quite important because if you’re not lending an index fund then it is unlikely that it is going to be a top quartile performer in its market. The relevance of lending in the context of changes in the asset management world is becoming much more prevalent.
Is the industry becoming more innovative in advance of the introduction of SFTR?
The regulation that we are seeing is demanding greater discipline and a greater transparency for things like SFTR. We should not forget that banks and institutions are subject to prudential capital regimes which will naturally restrict business.
They are looking for ever increasing ways to do business, to either minimise or use their capital more efficiently and that is why we have something like pledge coming along, which allows brokers to run their business in a different way, and reduce some of the risk weighted assets charges within their firm. Therefore, lending them through using a pledge model makes more sense from a capital efficiency perspective.
Another example is the use of central clearing, which offers similar benefits. We are also seeing a world where we all strive for more automation and straight through processing, and therefore reduced costs. But the business is actually getting more complex because even the choice of non-collateral, which you may choose to deploy in a particular trade could change the risk and capital dynamics of their transaction. Almost every single trade needs to be looked at in isolation, which is contrary to the idea of greater efficiency in automation. I am unsure of how that is going to play out—there are rather strong forces pulling in different ways.
The industry is currently waiting for the European Commission to start the formal adoption of the technical standards. What are you expecting these to consist of?
In looking at ESMA’s draft standards, we can see that some of the amended texts and standards clearly reflect some of the work we and other associations undertook during the consultation phase. I believe that it is important to operate in an open and collaborative way to the benefit of our broader membership and other stakeholders.
We are hoping that once the commission starts the adoption process and goes through the scrutiny period, which is one to three months, then we should be able to fire the implementation starting gun.
It is fair to say, that our market is ready to start implementation and we cannot keep it hanging around forever, we need to get going on this as quickly as possible.
What are you expecting to be the big talking points at the ISLA conference in Lisbon?
Inevitably, the topic of Brexit and what the world will look like post-Brexit and, of course, SFTR. We will be showcasing our new legal agreements and the Global Master Securities Lending Agreement pledge framework that should be available shortly. This will then be discussed in some detail in addition to the technical side of business on the Tuesday afternoon.
We will be talking about Brexit and inevitably there we will be discussions about how regulation and Brexit will change the operating model around the business, and what that will mean in terms of structural organisation.
We will also be looking at the future of investment; what does it mean around the changes in asset management behaviour and the drift from active to passive management—what about exchange-traded funds and UCITS? And can they play a larger role in the industry across Europe?
We also have a panel that will look, in detail, at technology. We will try to be specific about what this technology means in the context of our markets and hopefully give some perspective there. Hopefully, they will give an idea of the key factors that will shape decision making over the next two to three years.
What challenges do you see beyond this year?
In some ways, the most important challenge facing the industry will be figuring out the implementation of SFTR. We should not underestimate the idea that it is quite likely to draw in resource from other areas and projects. We have to get this right as an industry as the eyes of the regulatory world are upon us.
Further, as people begin to learn about SFTR they are going to want to revisit business models. Therefore, we may well see borrowers in Europe wanting to borrow securities from lenders in Europe only because both sides of the transaction have the same reporting obligation. The challenge for us is how much we can do against the backdrop of a fairly deep regulatory agenda. The big unknown there is about what is going to happen around Brexit because we could be looking at it as ‘business as usual’ or we could have a very different dynamic around our business, which we, as an association, are going to react to.
What will ISLA be working on over the next 12 months?
Looking at our key messaging, we want to talk with regulators and policy makers about the role of securities lending, and how we get that message out to our members and other interesting stakeholders across Europe. We would also like more engagement from relevant stakeholder areas across Europe in order to get our message out: the importance of lending in the context of the CMU across Europe will be crucial. That is where you are going to see more of us in the coming months.
First, is the extensive work that we are doing on the development of a new market standard agreement that will allow participants to move collateral onto a pledge rather than title-transfer basis, which is a new market wide agreement that is sitting alongside our other market standard agreements. And, that should be finalised in the next couple of weeks, ahead of our conference in Lisbon.
Secondly, there is work going on in regards with preparing for Securities Financing Transactions Regulation (SFTR). We are also carrying out background work on the UCITS landscape and their relative competitive position, and so when it comes to lending, we will be doing a lot of work there regarding regulators and policy makers trying to paint a picture around how UCITS should perhaps have a slightly bigger footprint when it comes to lending across European markets. Particularly so in the context of the Capital Markets Union (CMU) that will become more prevalent in a post-Brexit world. Those are the things that I would highlight at a top level.
Other things that we have been working on are our events, in particular our up and coming main conference in Lisbon, which is taking up quite a lot of resource at the moment.
How is ISLA preparing for SFTR?
SFTR is probably the single most important and wide-ranging reporting obligation that our market has ever seen, certainly in Europe, and it has its origins in the post-crisis regulatory agenda set by the Financial Stability Board (FSB) and particularly by the FSB workstream 5.
The SFTR covers: securities lending, repo, prime brokerage, and financing activities across Europe with a daily reporting requirement, our main focus is securities financing.
At the moment, we are still waiting for the European Commission to start the formal adoption process of the Technical Standards that were published by European Securities and Markets Authority (ESMA) in March 2017.
However, we feel that it is important for the industry to begin to mobilise and think about compliance because there is an awful lot to do once the commission fires the starting gun around implementation. In this pre-implementation phase, we will be looking closely at their Technical Standards when they are published by the commission to ensure that they are consistent with the draft Technical Standards that were published by ESMA last year.
Meanwhile, alongside other firms and industry stakeholders, we are beginning to take a detailed look at two very important issues. The first one is data, and the second revolves around the generation of unique transaction identifiers (UTIs). Taking data first, there are 97 data points in a securities lending transaction that are required to be reported on a daily basis. Lenders have to furnish all 97 data reporting points as part of the dual rating reporting regime. Borrowers also have a similar obligation but around about a quarter, approximately 24/25 fields that the borrowers have to report they can only get from the lenders.
There is a high level of market dependency between the two, and to facilitate a better understanding of these data points we have published an initial data dictionary that looks at the relative responsibility for each of the data points in the reporting regime, both loans and collateral and highlights where that data should come from, namely from either a lender, borrower or potentially elsewhere, such as a tri-party agent.
We have also identified how easy or hard we think those data points are in terms of accessibility and interpretation. We have data points that are green and would appear to present no material issues to market participants. We have two further categories that are amber and red. The amber ones need further work to agree to a common approach across the industry, and the third red group would appear to presents significant challenges to members.
My objective, as chief executive of ISLA, is to get a common understanding around the data points and a common interpretation across the industry, so that everybody is starting from the same point.
I do not have a real interest, and nor should I, in whether firms decide to use one particular commercial offering or another. Our main focus is to get everybody to the same starting point around understanding and we think that’s critically important, and we have so far received strong support from all elements of the industry to do that. We will continue with that work during the summer.
You recently said that SFTR is at “a very pivotal point”. What developments have there been since then?
In addition to data, we have started work around UTIs, which are the link in the chain when the trades are reported to trade repositories. We have issued guidance about market best practices and have suggested how the industry can do a better job of UTI generation. There is still some work to be done. It is not a finished article yet. An industry-wide approach around UTI’s will have considerable benefit to all concerned.
We have known for some time that a lot of loans come from lenders who are outside of Europe. About 60 percent of outstanding loans come from lenders outside of Europe, who themselves don’t have a reporting obligation under SFTR, but they do have a requirement to provide certain details of their loans to the borrowers who do have a reporting obligation. That dynamic is now raising some interesting questions from those communities outside of Europe about the need to do this, their willingness to do this, and the cost involved. Therefore, there is more to come in terms of what to talk about in that space.
How can firms ensure they approach SFTR correctly?
SFTR itself is a large, unyielding, and fairly difficult reporting obligation. I would not underestimate the amount of work needed to make this happen. But I also think that if firms think about it in a slightly broader way then this could be a great opportunity to address data flows, information flows, data aggregation and collection within their firms, and sweep away some of the legacy systems and processes we have seen in the past.Therefore, it is a great opportunity. There is a strong link to one of my favourite topics, which is agent lender disclosure (ALD). The market should use the mandatory requirements of SFTR as a springboard to re-examine the continued sustainability of ALD. In the long term, the two cannot co-exist because it does not make sense practically and economically to have the two operating in our market. The market needs to spend some time thinking a bit more about that.
Aside from dealing with data, what other trends are you currently seeing in the securities lending space?
We continue to see a market that is still very much split between debt and equities, the equity market has always been a big component of our industry. In the last couple of years, we have seen the rise of government bond lending and HQLA assets, and that trend continues. Therefore, we see securities lending becoming an equity pump for the broader capital markets. One of the factors that we are seeing in particular is to comply with much of the regulation that we have before us. Last week’s commission published a draft outlining their final technical standards on Central Securities Depository Regulation (CSDR)—the settlement discipline regime. To comply with all of this, you need to be a pretty large organisation to absorb all of these costs.
This means that having scale and significant size now appears to be an important factor in whether or not you’re successful in this market. That does not mean to say that you can’t be successful if you are small but I think it is more difficult. And that is completely out of line with what the commission would want here.
Regulators would generally like the markets to be full with people carrying out lots of things so that everybody has lots of choice. They like that in consumer markets and they like it in financial markets. But the burden of reporting that we’ve seen—particularly around financial services and our markets—means that increasingly firms just can’t actually absorb these costs. This is an important trend that we are beginning to see play out in the discussions that we are having. Lastly, the other big trend is the general drift towards passive asset management away from active asset management. This includes the rise of index funds.
Consequently, if you are managing to an index then securities lending becomes quite important because if you’re not lending an index fund then it is unlikely that it is going to be a top quartile performer in its market. The relevance of lending in the context of changes in the asset management world is becoming much more prevalent.
Is the industry becoming more innovative in advance of the introduction of SFTR?
The regulation that we are seeing is demanding greater discipline and a greater transparency for things like SFTR. We should not forget that banks and institutions are subject to prudential capital regimes which will naturally restrict business.
They are looking for ever increasing ways to do business, to either minimise or use their capital more efficiently and that is why we have something like pledge coming along, which allows brokers to run their business in a different way, and reduce some of the risk weighted assets charges within their firm. Therefore, lending them through using a pledge model makes more sense from a capital efficiency perspective.
Another example is the use of central clearing, which offers similar benefits. We are also seeing a world where we all strive for more automation and straight through processing, and therefore reduced costs. But the business is actually getting more complex because even the choice of non-collateral, which you may choose to deploy in a particular trade could change the risk and capital dynamics of their transaction. Almost every single trade needs to be looked at in isolation, which is contrary to the idea of greater efficiency in automation. I am unsure of how that is going to play out—there are rather strong forces pulling in different ways.
The industry is currently waiting for the European Commission to start the formal adoption of the technical standards. What are you expecting these to consist of?
In looking at ESMA’s draft standards, we can see that some of the amended texts and standards clearly reflect some of the work we and other associations undertook during the consultation phase. I believe that it is important to operate in an open and collaborative way to the benefit of our broader membership and other stakeholders.
We are hoping that once the commission starts the adoption process and goes through the scrutiny period, which is one to three months, then we should be able to fire the implementation starting gun.
It is fair to say, that our market is ready to start implementation and we cannot keep it hanging around forever, we need to get going on this as quickly as possible.
What are you expecting to be the big talking points at the ISLA conference in Lisbon?
Inevitably, the topic of Brexit and what the world will look like post-Brexit and, of course, SFTR. We will be showcasing our new legal agreements and the Global Master Securities Lending Agreement pledge framework that should be available shortly. This will then be discussed in some detail in addition to the technical side of business on the Tuesday afternoon.
We will be talking about Brexit and inevitably there we will be discussions about how regulation and Brexit will change the operating model around the business, and what that will mean in terms of structural organisation.
We will also be looking at the future of investment; what does it mean around the changes in asset management behaviour and the drift from active to passive management—what about exchange-traded funds and UCITS? And can they play a larger role in the industry across Europe?
We also have a panel that will look, in detail, at technology. We will try to be specific about what this technology means in the context of our markets and hopefully give some perspective there. Hopefully, they will give an idea of the key factors that will shape decision making over the next two to three years.
What challenges do you see beyond this year?
In some ways, the most important challenge facing the industry will be figuring out the implementation of SFTR. We should not underestimate the idea that it is quite likely to draw in resource from other areas and projects. We have to get this right as an industry as the eyes of the regulatory world are upon us.
Further, as people begin to learn about SFTR they are going to want to revisit business models. Therefore, we may well see borrowers in Europe wanting to borrow securities from lenders in Europe only because both sides of the transaction have the same reporting obligation. The challenge for us is how much we can do against the backdrop of a fairly deep regulatory agenda. The big unknown there is about what is going to happen around Brexit because we could be looking at it as ‘business as usual’ or we could have a very different dynamic around our business, which we, as an association, are going to react to.
What will ISLA be working on over the next 12 months?
Looking at our key messaging, we want to talk with regulators and policy makers about the role of securities lending, and how we get that message out to our members and other interesting stakeholders across Europe. We would also like more engagement from relevant stakeholder areas across Europe in order to get our message out: the importance of lending in the context of the CMU across Europe will be crucial. That is where you are going to see more of us in the coming months.
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