A difference of objectives: SFTR versus 10c-1
15 February 2022
Martin Walker, head of product, securities finance and collateral management at Broadridge, comments on contrasting US and EU approaches to securities finance transaction reporting
Image: stock.adobe.com/kmaglara
“Not again” is a cry being heard across the securities lending business as the Securities and Exchange Commission (SEC) seeks to introduce mandatory reporting of securities lending trades in the US under Rule 10c-1. Many securities lending businesses, which often operate on a global basis, have yet to recover from the trauma of the introduction of the EU’s Securities Finance Transaction Regulation (SFTR).
A large part of the SFTR trauma came from the sheer complexity of complying with the regulation. Up to 155 fields had to be reported for each transaction, over 10 times as many as under rule 10c-1. Many of those fields were not even stored in the systems of those having to do the reporting and the dual-sided nature of the reporting created the need for another reconciliation to be put in place between each party involved in a stock loan.
10c-1 looks, in general, like a far simpler regulation, covering less types of trading, needing only basic data about trades to be reported and only requiring reporting by one party to the trade: the lender or lending agent.
In spite of the technical differences in the design of SFTR and 10c-1, one of the most interesting differences is the core objectives of the relevant regulators. SFTR was designed to support macro-prudential regulation — regulation aimed at monitoring and reducing risks to the stability of the overall financial system. The original European Union documentation stated:
"In the context of its work to curb shadow banking, the Financial Stability Board (FSB) and the European Systemic Risk Board (ESRB) established by Regulation (EU) No 1092/2010 of the European Parliament and of the Council (5) have identified the risks posed by securities financing transactions (SFTs). SFTs allow the build-up of leverage, pro-cyclicality and interconnectedness in the financial markets. In particular, a lack of transparency in the use of SFTs has prevented regulators and supervisors as well as investors from correctly assessing and monitoring the respective bank-like risks and level of interconnectedness in the financial system in the period preceding and during the financial crisis."
In line with those original objectives, the primary users of the data collected under SFTR have been the European (and UK) central banks rather than regulators responsible for financial conduct. In fact, there has been a heavy focus simply on reviewing the data quality of the 155 fields because of poor quality data or rejected data preventing central bankers from loading data into their models. The poor quality of data (perhaps a consequence of overcomplicated requirements) makes the data very hard to use for conduct-related regulation, even if conduct-focused regulators such as the FCA or BAFIN attempted to make more use of it.
Data quality issues, plus the way data is released to the public (both in terms of the level of aggregation and timeliness), make it very hard to use SFTR data in day-to-day trading decisions. This has led to it having little to no impact on the efficiency of the EU and UK stock lending markets, while adding significant operational and compliance costs.
In contrast, the objectives of the SEC are very focused on improving the operation of the securities lending market as well as conduct-related regulation.
According to the SEC, the subsequent benefits include “a reduction of the information disadvantage faced by end borrowers and beneficial owners in the securities lending market, improved price discovery in the securities lending market, increased competition among providers of securities lending analytics services, reduced administrative costs for broker-dealers and lending programmes, and improved balance sheet management for financial institutions”.
In its preliminary analysis, the Commission also believes that the proposed Rule would be likely to reduce the cost of short selling, leading to improved price discovery and liquidity in the underlying security markets.
The focus on conduct is explicitly spelt out.
The Commission also indicates that the proposed Rule would benefit investors by increasing the ability of regulators to supervise, study, and provide oversight of both the securities lending market and individual market participants.
One of the major historic differences between short selling in the US and European equity markets has been the emphasis of US regulators on short sellers checking the availability of stock for borrowing, to cover their shorts, before they do a short sale. Failure to follow this “locates” process — and to document that it has received a locate confirmation from a lender — can lead to major penalties. The requirement under 10c-1 for firms to report stocks available for loan as well as stocks on loan (at the end of each business day), would provide a powerful tool for the SEC to verify whether locate requests are being checked against accurate data for loan availability.
Coupled with other data, the Commission could identify short sale orders, short sellers, and their broker-dealers who are active in such securities, which would allow the Commission to target broker-dealers more efficiently for locate examinations.
This difference in emphasis is probably one of the reasons why the SEC has created a regulation that is in many ways simpler and easier to comply with than SFTR — at least in terms of sourcing and reporting data — but one where there is likely to be less tolerance of the data quality issues that have bedevilled SFTR. It is also a regulation which, if implemented in its current form, is likely to have far more impact on the operation of the US securities lending market than SFTR has had on the EU and UK markets.
In coming articles in this series, we will examine the potential impacts in more detail and the disconnect between how regulators and participants view the operation of the market.
A large part of the SFTR trauma came from the sheer complexity of complying with the regulation. Up to 155 fields had to be reported for each transaction, over 10 times as many as under rule 10c-1. Many of those fields were not even stored in the systems of those having to do the reporting and the dual-sided nature of the reporting created the need for another reconciliation to be put in place between each party involved in a stock loan.
10c-1 looks, in general, like a far simpler regulation, covering less types of trading, needing only basic data about trades to be reported and only requiring reporting by one party to the trade: the lender or lending agent.
In spite of the technical differences in the design of SFTR and 10c-1, one of the most interesting differences is the core objectives of the relevant regulators. SFTR was designed to support macro-prudential regulation — regulation aimed at monitoring and reducing risks to the stability of the overall financial system. The original European Union documentation stated:
"In the context of its work to curb shadow banking, the Financial Stability Board (FSB) and the European Systemic Risk Board (ESRB) established by Regulation (EU) No 1092/2010 of the European Parliament and of the Council (5) have identified the risks posed by securities financing transactions (SFTs). SFTs allow the build-up of leverage, pro-cyclicality and interconnectedness in the financial markets. In particular, a lack of transparency in the use of SFTs has prevented regulators and supervisors as well as investors from correctly assessing and monitoring the respective bank-like risks and level of interconnectedness in the financial system in the period preceding and during the financial crisis."
In line with those original objectives, the primary users of the data collected under SFTR have been the European (and UK) central banks rather than regulators responsible for financial conduct. In fact, there has been a heavy focus simply on reviewing the data quality of the 155 fields because of poor quality data or rejected data preventing central bankers from loading data into their models. The poor quality of data (perhaps a consequence of overcomplicated requirements) makes the data very hard to use for conduct-related regulation, even if conduct-focused regulators such as the FCA or BAFIN attempted to make more use of it.
Data quality issues, plus the way data is released to the public (both in terms of the level of aggregation and timeliness), make it very hard to use SFTR data in day-to-day trading decisions. This has led to it having little to no impact on the efficiency of the EU and UK stock lending markets, while adding significant operational and compliance costs.
In contrast, the objectives of the SEC are very focused on improving the operation of the securities lending market as well as conduct-related regulation.
According to the SEC, the subsequent benefits include “a reduction of the information disadvantage faced by end borrowers and beneficial owners in the securities lending market, improved price discovery in the securities lending market, increased competition among providers of securities lending analytics services, reduced administrative costs for broker-dealers and lending programmes, and improved balance sheet management for financial institutions”.
In its preliminary analysis, the Commission also believes that the proposed Rule would be likely to reduce the cost of short selling, leading to improved price discovery and liquidity in the underlying security markets.
The focus on conduct is explicitly spelt out.
The Commission also indicates that the proposed Rule would benefit investors by increasing the ability of regulators to supervise, study, and provide oversight of both the securities lending market and individual market participants.
One of the major historic differences between short selling in the US and European equity markets has been the emphasis of US regulators on short sellers checking the availability of stock for borrowing, to cover their shorts, before they do a short sale. Failure to follow this “locates” process — and to document that it has received a locate confirmation from a lender — can lead to major penalties. The requirement under 10c-1 for firms to report stocks available for loan as well as stocks on loan (at the end of each business day), would provide a powerful tool for the SEC to verify whether locate requests are being checked against accurate data for loan availability.
Coupled with other data, the Commission could identify short sale orders, short sellers, and their broker-dealers who are active in such securities, which would allow the Commission to target broker-dealers more efficiently for locate examinations.
This difference in emphasis is probably one of the reasons why the SEC has created a regulation that is in many ways simpler and easier to comply with than SFTR — at least in terms of sourcing and reporting data — but one where there is likely to be less tolerance of the data quality issues that have bedevilled SFTR. It is also a regulation which, if implemented in its current form, is likely to have far more impact on the operation of the US securities lending market than SFTR has had on the EU and UK markets.
In coming articles in this series, we will examine the potential impacts in more detail and the disconnect between how regulators and participants view the operation of the market.
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