SFTR: the real looming effect
13 February 2018
Although MiFID II has had no immediate effects on the securities lending market, industry participants suggest that the real looming effect of MiFID II will come in the form of SFTR
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The second Markets in Financial Instruments Directive (MiFID II) has had no immediate overwhelming effect upon the securities lending market. However, the effect is looming in H1 2019, when the Securities Finance Transaction Reporting (SFTR) kicks in, under the auspices of the European Securities and Markets Authority (ESMA).
This is evident from conversations undertaken with a range of market players. A spokesperson for Societe Generale prime brokerage, for example, points out in some detail that under MiFID II/Markets in Financial Instruments Regulation, Securities Financing Transactions (SFTs) are subject only to some of the MiFID II provisions. Transaction reporting does not apply to SFTs except when traded with a bank from the European System of Central Banks (ESCB) and from the day SFTR starts—currently scheduled around Q2 2019.
SFTs are excluded from requirements relating to pre- and post-trade transparency under article 1.5a of MiFIR: 5a. Title II and Title III, shall not apply to securities financing transactions as defined in point (11) of Article 3 of Regulation (EU) 2015/2365 of the European Parliament and the Council (1).
The spokesperson from Societe Generale adds: “As far as market prices are concerned, we have seen nothing significant. It is best described as a non-event.”
Andy Dyson, CEO at the International Securities Lending Association (ISLA), suggests that there is no doubt that SFTR is a bigger deal than MiFID II, even if its exact details on transparency and reporting obligations are taking longer than expected to materialise.
Agreeing with Dyson, Jamila Jeffcoate, head of securities lending agency at State Street Global Markets Europe, the Middle East and Africa, explains that there has been little impact on day-to-day trading or relationship management services post-MiFID II implementation. The impact has been on what she describes as the significant amount of working hours dedicated to the regulation.
Firstly, interpreting the guidelines and their relevance for securities lending, and then providing clients with necessary information and disclosures. Secondly, establishing controls and procedures to meet the 3 January deadline resulted in an end-of-year push that consumed resources across the business.
Jeffcoate suggests: “It has taken enormous time and energy but of-course we had no option but to be compliant.”
Securities lending fits into the MiFID II environment in the way that a square peg fits into a round hole, according to Jeffcoate. Regarding the rules around trade confirmations, for lenders and borrowers alike, MiFID II has generated paper in great volume but to little or no real effect.
She adds that the real looming effects of MiFID II for the securities lending industry will come in the form of SFTR.
Jeffcoate says: “Under SFTR all securities lending transactions are required to be reported on trade day plus one to a trade repository, all within a new framework of transparency and disclosure.”
“This is a significant undertaking for both sides of the trade with both lender and borrower required to report.”
Dyson also emphasises that the cost of compliance is not cheap.
The new arrangements will inevitably increase costs, and those costs will have to be covered one way or another. This could be achieved by increasing fees or reducing fee rebates (two sides of the same coin), by changing the locus of lending and borrowing activity, or by client withdrawal from the product. If the cost of compliance renders securities lending uneconomic, marginal players could in effect find themselves being pushed out of the market. If this happens, it will have implications for liquidity. Dyson explains: “That worries us a bit.”
Jeffcoate adds: “This is a European directive that impacts European legal entities or EU branches of non-EU entities.”
“Where one side of the SFT meets this criteria, that transaction must be reported with a subsequent cost. In response, borrowers will be forced to be more selective in their choice of the lending counterparty.”
Dyson calculates that around 60 percent of outstanding loans in Europe come from lenders not in Europe. If institutions in Asia and North America are required to comply with legislation outside their domicile they might decide not to lend to Europe, he adds.
He explains: “We support transparency 100 percent and believe there should be full and appropriate regulation, but we need to create value for institutional investors.”
“The North American regime has a lighter touch in terms of regulation and we see a potential change in the strategic thinking of institutional investors. European securities lending could go elsewhere or just stop. I don’t want to be over-alarmist, but that is a possibility.”
This is one of the contributory factors to development that Jeffcoate describes as ‘smart bucketing’. The concept of ‘smart bucketing’ could enable borrowers to source stock from groups of beneficial owners that share the same profile or characteristics, such as legal entity structure, domicile, collateral flexibility and tenor.
“If lenders can segment availability in this way it enables borrowers to make more informed decisions about pricing based on capital and credit exposure, as well as SFTR impact,” according to Jeffcoate.
“There is no doubt that SFTR will lead to a change in the traditional agency lender operating model. Although some agent lenders can offer this level of transparency today, the majority of US lenders operate under a ‘queue’ system that bulks beneficial owner supply into the loan transaction based on a fairness algorithm. A move to smart bucketing throws the queue principal on its head as it would introduce a new allocation methodology.”
Mark Jones, head of international product management, securities lending at Northern Trust, also weighed in. Some of his musings echo those of his peer group; some do not. Jones suggests: “From our perspective as an agent lender MiFID II has had an impact, although not to the same level of magnitude as for other product lines.”
He adds: “Our main challenge has been interpreting the regulation as it pertains to our product and in particular an agent securities lending programme. While the requirements are fairly obvious when applied to products such as brokerage or foreign exchange (FX), for example best execution, applying them to an agency programme and the way they are structured has been slightly more problematic and required more interpretation in a number of ‘grey’ areas.”
“The exemption of the majority of SFTs from transaction reporting under MiFID II is the main difference between our product and others, though it is worth noting that the SFTR regime, which will capture the majority of our activity is edging ever closer.”
“We have not seen any major impacts in market activity since MiFID II came into force. The main areas of impact in the securities lending market have been between service providers and their underlying clients. With one of the focus points of the directive being to increase transparency and to provide a clearer representation of costs and charges to clients, there has been a flurry of communication between providers and their client base including various consents and disclosures being exchanged.”
“Additionally, there are new ongoing reporting obligations that must be met such as the disclosure of trading venues. While we haven’t seen any impacts to aspects such as supply or pricing, we are only a month in and other impacts may filter through in time. That said, we are not expecting a wholesale change in market activity.”
“Beneficial owners may be seeing more information from their agents, although I think that historically we have been strong in this area and MiFID II has not required significant change,” he continues. “I don’t necessarily expect MiFID II to be a driving factor in whether investors choose to lend or not, if anything, the focus on transparency could encourage beneficial owners as they gain a better understanding of the service from the information made available to them.”
Mixed up in all of the above is, inevitably, Brexit. Which brings us to the kind of irony that has long characterised Britain’s membership of the EU. While the UK’s attitude to the EU has often been one of deep suspicion since accession in 1973, the country is paradoxically renowned for its practice of ‘gold plating’ EU-inspired legislation, going further in the implementation of directives than the non-elected bureaucrats who dreamed them up could ever have hoped for. Compare the near-Arctic temperature in any UK supermarkets chilled food section with that in any EU counterpart for easy reference.
Dyson explains: “The UK’s is possibly the best-prepared regime for MiFID II. And we are leaving.”
This is evident from conversations undertaken with a range of market players. A spokesperson for Societe Generale prime brokerage, for example, points out in some detail that under MiFID II/Markets in Financial Instruments Regulation, Securities Financing Transactions (SFTs) are subject only to some of the MiFID II provisions. Transaction reporting does not apply to SFTs except when traded with a bank from the European System of Central Banks (ESCB) and from the day SFTR starts—currently scheduled around Q2 2019.
SFTs are excluded from requirements relating to pre- and post-trade transparency under article 1.5a of MiFIR: 5a. Title II and Title III, shall not apply to securities financing transactions as defined in point (11) of Article 3 of Regulation (EU) 2015/2365 of the European Parliament and the Council (1).
The spokesperson from Societe Generale adds: “As far as market prices are concerned, we have seen nothing significant. It is best described as a non-event.”
Andy Dyson, CEO at the International Securities Lending Association (ISLA), suggests that there is no doubt that SFTR is a bigger deal than MiFID II, even if its exact details on transparency and reporting obligations are taking longer than expected to materialise.
Agreeing with Dyson, Jamila Jeffcoate, head of securities lending agency at State Street Global Markets Europe, the Middle East and Africa, explains that there has been little impact on day-to-day trading or relationship management services post-MiFID II implementation. The impact has been on what she describes as the significant amount of working hours dedicated to the regulation.
Firstly, interpreting the guidelines and their relevance for securities lending, and then providing clients with necessary information and disclosures. Secondly, establishing controls and procedures to meet the 3 January deadline resulted in an end-of-year push that consumed resources across the business.
Jeffcoate suggests: “It has taken enormous time and energy but of-course we had no option but to be compliant.”
Securities lending fits into the MiFID II environment in the way that a square peg fits into a round hole, according to Jeffcoate. Regarding the rules around trade confirmations, for lenders and borrowers alike, MiFID II has generated paper in great volume but to little or no real effect.
She adds that the real looming effects of MiFID II for the securities lending industry will come in the form of SFTR.
Jeffcoate says: “Under SFTR all securities lending transactions are required to be reported on trade day plus one to a trade repository, all within a new framework of transparency and disclosure.”
“This is a significant undertaking for both sides of the trade with both lender and borrower required to report.”
Dyson also emphasises that the cost of compliance is not cheap.
The new arrangements will inevitably increase costs, and those costs will have to be covered one way or another. This could be achieved by increasing fees or reducing fee rebates (two sides of the same coin), by changing the locus of lending and borrowing activity, or by client withdrawal from the product. If the cost of compliance renders securities lending uneconomic, marginal players could in effect find themselves being pushed out of the market. If this happens, it will have implications for liquidity. Dyson explains: “That worries us a bit.”
Jeffcoate adds: “This is a European directive that impacts European legal entities or EU branches of non-EU entities.”
“Where one side of the SFT meets this criteria, that transaction must be reported with a subsequent cost. In response, borrowers will be forced to be more selective in their choice of the lending counterparty.”
Dyson calculates that around 60 percent of outstanding loans in Europe come from lenders not in Europe. If institutions in Asia and North America are required to comply with legislation outside their domicile they might decide not to lend to Europe, he adds.
He explains: “We support transparency 100 percent and believe there should be full and appropriate regulation, but we need to create value for institutional investors.”
“The North American regime has a lighter touch in terms of regulation and we see a potential change in the strategic thinking of institutional investors. European securities lending could go elsewhere or just stop. I don’t want to be over-alarmist, but that is a possibility.”
This is one of the contributory factors to development that Jeffcoate describes as ‘smart bucketing’. The concept of ‘smart bucketing’ could enable borrowers to source stock from groups of beneficial owners that share the same profile or characteristics, such as legal entity structure, domicile, collateral flexibility and tenor.
“If lenders can segment availability in this way it enables borrowers to make more informed decisions about pricing based on capital and credit exposure, as well as SFTR impact,” according to Jeffcoate.
“There is no doubt that SFTR will lead to a change in the traditional agency lender operating model. Although some agent lenders can offer this level of transparency today, the majority of US lenders operate under a ‘queue’ system that bulks beneficial owner supply into the loan transaction based on a fairness algorithm. A move to smart bucketing throws the queue principal on its head as it would introduce a new allocation methodology.”
Mark Jones, head of international product management, securities lending at Northern Trust, also weighed in. Some of his musings echo those of his peer group; some do not. Jones suggests: “From our perspective as an agent lender MiFID II has had an impact, although not to the same level of magnitude as for other product lines.”
He adds: “Our main challenge has been interpreting the regulation as it pertains to our product and in particular an agent securities lending programme. While the requirements are fairly obvious when applied to products such as brokerage or foreign exchange (FX), for example best execution, applying them to an agency programme and the way they are structured has been slightly more problematic and required more interpretation in a number of ‘grey’ areas.”
“The exemption of the majority of SFTs from transaction reporting under MiFID II is the main difference between our product and others, though it is worth noting that the SFTR regime, which will capture the majority of our activity is edging ever closer.”
“We have not seen any major impacts in market activity since MiFID II came into force. The main areas of impact in the securities lending market have been between service providers and their underlying clients. With one of the focus points of the directive being to increase transparency and to provide a clearer representation of costs and charges to clients, there has been a flurry of communication between providers and their client base including various consents and disclosures being exchanged.”
“Additionally, there are new ongoing reporting obligations that must be met such as the disclosure of trading venues. While we haven’t seen any impacts to aspects such as supply or pricing, we are only a month in and other impacts may filter through in time. That said, we are not expecting a wholesale change in market activity.”
“Beneficial owners may be seeing more information from their agents, although I think that historically we have been strong in this area and MiFID II has not required significant change,” he continues. “I don’t necessarily expect MiFID II to be a driving factor in whether investors choose to lend or not, if anything, the focus on transparency could encourage beneficial owners as they gain a better understanding of the service from the information made available to them.”
Mixed up in all of the above is, inevitably, Brexit. Which brings us to the kind of irony that has long characterised Britain’s membership of the EU. While the UK’s attitude to the EU has often been one of deep suspicion since accession in 1973, the country is paradoxically renowned for its practice of ‘gold plating’ EU-inspired legislation, going further in the implementation of directives than the non-elected bureaucrats who dreamed them up could ever have hoped for. Compare the near-Arctic temperature in any UK supermarkets chilled food section with that in any EU counterpart for easy reference.
Dyson explains: “The UK’s is possibly the best-prepared regime for MiFID II. And we are leaving.”
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The convergence of securities finance and collateral: one business, two systems?
The convergence of securities finance and collateral: one business, two systems?
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