ESMA raises concern of leverage from SFTs
05 October 2016 Paris
Image: Shutterstock
The European Securities and Markets Authority (ESMA) has suggested that securities finance transactions (SFTs) lead to a build up of leverage that could threaten financial stability.
According to a recent ESMA report, this increase in market leverage has not yet been addressed by the existing regulatory framework in Europe.
The authority highlighted a highly-leveraged system can be “vulnerable to runs”, generate contagion risk and increase procyclicality.
ESMA acknowledged that a lack of granular industry data did limit its ability to pass sound judgement on potential risk, which will continue to be a problem until the Securities Financing Transactions Regulation’s (SFTR) reporting standards are in effect, according to the authority.
In light of the potential leverage issue the industry presents, ESMA endorsed the Financial Stability Board’s (FSB) qualitative standards on the methodology used to calculate haircuts in non-centrally cleared SFTs, which should be introduced as a first step to improve the transparency and stability of haircuts, and the resilience of financial institutions.
Additionally, the procyclicality of collateral haircuts used by central counterparties should be addressed in the context of the European Markets Infrastructure Regulation review.
ESMA noted, however, that a haircut floors for non-centrally cleared transactions can only be introduced and calibrated following a thorough analysis using granular SFT data and "following careful assessment of the scope, considering in particular the size and relevance of EU government bond markets".
“Other macroprudential instruments, including counter-cyclical ones, should be agreed at international level first, and can only be introduced after a careful assessment that the already introduced measures are not sufficient to limit the leverage in the system,” ESMA added.
“Only subject to these two conditions can it be considered whether additional macro-prudential instruments would still be needed.”
Steven Maijoor, ESMA chair, said of the report: “The ESMA report is an important stock-take of European SFTs markets. Looking at the sheer size of repo transactions only, with over €5 trillion in gross amount outstanding, it shows the importance of bringing transparency to these activities. Besides being an important means of non-bank financing, the leverage SFTs create need to be looked at from a systemic risk angle.”
“The ESMA report also shows that it is too early, at this stage, to draw definitive conclusions on the efficiency of numerical haircut floors on non-centrally cleared SFTs to reduce pro-cyclicality in the EU. Having access to high-quality SFT data is essential to assess the scope and calibration of numerical haircut floors.”
According to a recent ESMA report, this increase in market leverage has not yet been addressed by the existing regulatory framework in Europe.
The authority highlighted a highly-leveraged system can be “vulnerable to runs”, generate contagion risk and increase procyclicality.
ESMA acknowledged that a lack of granular industry data did limit its ability to pass sound judgement on potential risk, which will continue to be a problem until the Securities Financing Transactions Regulation’s (SFTR) reporting standards are in effect, according to the authority.
In light of the potential leverage issue the industry presents, ESMA endorsed the Financial Stability Board’s (FSB) qualitative standards on the methodology used to calculate haircuts in non-centrally cleared SFTs, which should be introduced as a first step to improve the transparency and stability of haircuts, and the resilience of financial institutions.
Additionally, the procyclicality of collateral haircuts used by central counterparties should be addressed in the context of the European Markets Infrastructure Regulation review.
ESMA noted, however, that a haircut floors for non-centrally cleared transactions can only be introduced and calibrated following a thorough analysis using granular SFT data and "following careful assessment of the scope, considering in particular the size and relevance of EU government bond markets".
“Other macroprudential instruments, including counter-cyclical ones, should be agreed at international level first, and can only be introduced after a careful assessment that the already introduced measures are not sufficient to limit the leverage in the system,” ESMA added.
“Only subject to these two conditions can it be considered whether additional macro-prudential instruments would still be needed.”
Steven Maijoor, ESMA chair, said of the report: “The ESMA report is an important stock-take of European SFTs markets. Looking at the sheer size of repo transactions only, with over €5 trillion in gross amount outstanding, it shows the importance of bringing transparency to these activities. Besides being an important means of non-bank financing, the leverage SFTs create need to be looked at from a systemic risk angle.”
“The ESMA report also shows that it is too early, at this stage, to draw definitive conclusions on the efficiency of numerical haircut floors on non-centrally cleared SFTs to reduce pro-cyclicality in the EU. Having access to high-quality SFT data is essential to assess the scope and calibration of numerical haircut floors.”
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