Strength in numbers
26 April 2016
The SFTR’s technical details still need to be thrashed out, but early reports suggest that the securities lending industry has its work cut out
Image: Shutterstock
The initial wave of the Securities Financing Transaction Regulation (SFTR) hit the industry on 12 January 2016, but a series of equally disruptive aftershocks still need to be weathered, and senior industry figures fear that, without industry-wide cooperation, participants won’t be ready.
The European Securities Markets Authority’s (ESMA) SFTR requirements are driven by a desire for greater transparency in the securities financing market, with a particular focus on quantifying and mitigating market risk posed by ‘shadow banking’.
The primary way this aim is being enforced is through the SFTR’s level two regulatory technical standards (RTS) on reporting and recordkeeping for all securities financing transactions (SFTs). The level two RTS that is expected to clearly outline the exact requirements for this reporting is not due until Q2 2017, but the basic outline, that many expect to closely resemble the final product, is already available.
The requirements, as they currently stand, bring a level of granularity to reporting that the securities finance market has never seen before, with data disclosure down to the transaction level required from both the buy and sell sides on a T+1 basis.
Additionally to the initial reporting, the SFTR requires the creation of a transaction-level record system for all SFTs that must hold each firm’s business dealings for at least five years following the transaction’s completion.
Considering the scope of the overhaul of SFT reporting and the relatively short timeframe to implement it, some are concerned that industry investment and focus on the reporting standards of the SFTR has been lacking, to the point where some market participants might be caught short come deadline day.
“There is no doubt that the reporting requirements under the SFTR are some of the largest, most comprehensive and detailed reporting requirements industry has ever seen from a regulator,” explains International Securities Lending Association (ISLA) COO Andy Dyson.
“For the first time in our industry we are being asked to report all our data to a trade repository. There are a number of things that are brand new to the securities lending market,” Dyson adds.
“From ISLA’s perspective, despite all the industry education we’ve done on these issues, it’s only now in Q1 2016 that we see the industry paying full attention to SFTR reporting demands.”
“However, ISLA has been telling the industry for three years now that if they don’t already have legal entity identifiers (LEIs) in their systems you need to invest quickly because they are coming. Now there is a huge amount of focus on this area of the SFTR and the ISLA working group is meeting regularly to thrash out some of the broader technical issues.”
“The problem is that until we see the actual draft technical standards, which aren’t due until the middle of 2016, people can’t start changing their systems. All we know for sure at this point is that changes will be needed and some could be very significant.”
The decision to stagger the deadlines for SFTR’s various requirements into nine deadlines spread between 2016 and 2019 was meant, in part, to offer industry participants some respite from the significant technological investment costs that such detailed reporting terms inevitably require.
Simply upgrading your infrastructure’s storage capabilities may be enough to enable compliance with the five-year transaction filings, but the leap to transaction-level reporting demands something most firm’s existing systems simply do not possess.
“The industry will have to start using digital data tags, such as LEIs, which we haven’t seen before. Systems will have to be upgraded in order to cope with these new data points,” says Dyson.
“Lenders and borrowers will both report transactions, which will be linked by a unique trade identifier (UTI) reference. UTIs will then be used by regulators to remove double counts.”
“For the infrastructure technical build there are now new features that must be included.”
“In terms of costs, firms don’t have a lot of room to manoeuvre because there is a regulatory compliance requirement and if you haven’t got that in place by the end of 2017, or Q1 2018, you run the risk of being fined.”
Laurence Marshall, head of EquiLend Europe, echoed these concerns, stating: “The level of transparency that is proposed is far greater than present proposals in other jurisdictions. As much as the proposals have looked to limit operational costs to market participants by aligning formats to existing reporting requirements under other EU regulations, this will create a huge challenge and additional cost for the industry.”
“ESMA is proposing a robust legal and technological framework, and the standardisation of reporting formats and communication protocols is most helpful.”
“However, it does require participants to use ISO 20022, which some may not have adopted yet. It is likely that for securities lending transactions the majority will favour the use of a new template as opposed to the option of a template that is consistent with the European Markets Infrastructure Regulation (EMIR).”
Given the formidable scale of the task facing securities financing, industry associations such as ISLA, along with others, are loudly calling for a united approach to creating a workable solution.
“The crucial point that ISLA has argued throughout this process is that it’s important that the whole market looks for opportunities for collaboration that would share the burden and cut down on the time to market for these solutions,” Dyson explains.
“If every single firm tries to work out their own solution it’s going to be problematic and runs the risk these individual solutions won’t communicate with each other.”
“At the very least it’s important that the industry comes up with some common standards and common themes of approach to the various requirements. It may be that some of those functions are built by third-parties, like matching services or trading platforms, for the benefit of the whole industry.”
“We are all commercial organisations but if we continue to do things separately the benefits of synergies will be lost and people will struggle to hit the deadlines.”
Again, Marshall reinforces the point that cooperation is the key to minimising market disruption, stating: “The challenge for participants will be extracting the required information, which is likely to come from a multitude of sources. While the use of LEIs should be relatively straightforward, it might require some system changes.”
“UTIs, on the other hand, will provide a bigger challenge. Existing infrastructure providers are in a position to provide UTIs to participants and alleviate the need for participants to create a solution and bilaterally agree who is responsible for issuing.”
The good news for the securities financing industry is that when it comes to UTIs and LEIs, it has the advantage of being able to observe and learn from the difficulties that those who have already embraced these changes had to face. Even better, it seems the regulator is doing the same.
“ESMA is going about this consultation in exactly the right way. It received the level one text and reached out to various industry participants, including ISLA, on a bilateral basis to get a sense of how we are all feeling about the regulation. That happened in late 2015 and early 2016 and now ESMA has published a discussion paper,” Dyson says.
“What’s clear from the discussion paper is that the regulator has tried to learn from some of the much discussed issues in EMIR’s reporting regime for over-the-counter and un-cleared derivatives. They have clearly taken note of some of the problems that have arisen there, which is good.”
The European Securities Markets Authority’s (ESMA) SFTR requirements are driven by a desire for greater transparency in the securities financing market, with a particular focus on quantifying and mitigating market risk posed by ‘shadow banking’.
The primary way this aim is being enforced is through the SFTR’s level two regulatory technical standards (RTS) on reporting and recordkeeping for all securities financing transactions (SFTs). The level two RTS that is expected to clearly outline the exact requirements for this reporting is not due until Q2 2017, but the basic outline, that many expect to closely resemble the final product, is already available.
The requirements, as they currently stand, bring a level of granularity to reporting that the securities finance market has never seen before, with data disclosure down to the transaction level required from both the buy and sell sides on a T+1 basis.
Additionally to the initial reporting, the SFTR requires the creation of a transaction-level record system for all SFTs that must hold each firm’s business dealings for at least five years following the transaction’s completion.
Considering the scope of the overhaul of SFT reporting and the relatively short timeframe to implement it, some are concerned that industry investment and focus on the reporting standards of the SFTR has been lacking, to the point where some market participants might be caught short come deadline day.
“There is no doubt that the reporting requirements under the SFTR are some of the largest, most comprehensive and detailed reporting requirements industry has ever seen from a regulator,” explains International Securities Lending Association (ISLA) COO Andy Dyson.
“For the first time in our industry we are being asked to report all our data to a trade repository. There are a number of things that are brand new to the securities lending market,” Dyson adds.
“From ISLA’s perspective, despite all the industry education we’ve done on these issues, it’s only now in Q1 2016 that we see the industry paying full attention to SFTR reporting demands.”
“However, ISLA has been telling the industry for three years now that if they don’t already have legal entity identifiers (LEIs) in their systems you need to invest quickly because they are coming. Now there is a huge amount of focus on this area of the SFTR and the ISLA working group is meeting regularly to thrash out some of the broader technical issues.”
“The problem is that until we see the actual draft technical standards, which aren’t due until the middle of 2016, people can’t start changing their systems. All we know for sure at this point is that changes will be needed and some could be very significant.”
The decision to stagger the deadlines for SFTR’s various requirements into nine deadlines spread between 2016 and 2019 was meant, in part, to offer industry participants some respite from the significant technological investment costs that such detailed reporting terms inevitably require.
Simply upgrading your infrastructure’s storage capabilities may be enough to enable compliance with the five-year transaction filings, but the leap to transaction-level reporting demands something most firm’s existing systems simply do not possess.
“The industry will have to start using digital data tags, such as LEIs, which we haven’t seen before. Systems will have to be upgraded in order to cope with these new data points,” says Dyson.
“Lenders and borrowers will both report transactions, which will be linked by a unique trade identifier (UTI) reference. UTIs will then be used by regulators to remove double counts.”
“For the infrastructure technical build there are now new features that must be included.”
“In terms of costs, firms don’t have a lot of room to manoeuvre because there is a regulatory compliance requirement and if you haven’t got that in place by the end of 2017, or Q1 2018, you run the risk of being fined.”
Laurence Marshall, head of EquiLend Europe, echoed these concerns, stating: “The level of transparency that is proposed is far greater than present proposals in other jurisdictions. As much as the proposals have looked to limit operational costs to market participants by aligning formats to existing reporting requirements under other EU regulations, this will create a huge challenge and additional cost for the industry.”
“ESMA is proposing a robust legal and technological framework, and the standardisation of reporting formats and communication protocols is most helpful.”
“However, it does require participants to use ISO 20022, which some may not have adopted yet. It is likely that for securities lending transactions the majority will favour the use of a new template as opposed to the option of a template that is consistent with the European Markets Infrastructure Regulation (EMIR).”
Given the formidable scale of the task facing securities financing, industry associations such as ISLA, along with others, are loudly calling for a united approach to creating a workable solution.
“The crucial point that ISLA has argued throughout this process is that it’s important that the whole market looks for opportunities for collaboration that would share the burden and cut down on the time to market for these solutions,” Dyson explains.
“If every single firm tries to work out their own solution it’s going to be problematic and runs the risk these individual solutions won’t communicate with each other.”
“At the very least it’s important that the industry comes up with some common standards and common themes of approach to the various requirements. It may be that some of those functions are built by third-parties, like matching services or trading platforms, for the benefit of the whole industry.”
“We are all commercial organisations but if we continue to do things separately the benefits of synergies will be lost and people will struggle to hit the deadlines.”
Again, Marshall reinforces the point that cooperation is the key to minimising market disruption, stating: “The challenge for participants will be extracting the required information, which is likely to come from a multitude of sources. While the use of LEIs should be relatively straightforward, it might require some system changes.”
“UTIs, on the other hand, will provide a bigger challenge. Existing infrastructure providers are in a position to provide UTIs to participants and alleviate the need for participants to create a solution and bilaterally agree who is responsible for issuing.”
The good news for the securities financing industry is that when it comes to UTIs and LEIs, it has the advantage of being able to observe and learn from the difficulties that those who have already embraced these changes had to face. Even better, it seems the regulator is doing the same.
“ESMA is going about this consultation in exactly the right way. It received the level one text and reached out to various industry participants, including ISLA, on a bilateral basis to get a sense of how we are all feeling about the regulation. That happened in late 2015 and early 2016 and now ESMA has published a discussion paper,” Dyson says.
“What’s clear from the discussion paper is that the regulator has tried to learn from some of the much discussed issues in EMIR’s reporting regime for over-the-counter and un-cleared derivatives. They have clearly taken note of some of the problems that have arisen there, which is good.”
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