SFTR will start to phase in for the largest market participants in 2019, but there is much to prepare between now and then, from legal documentation to referential data sourcing and aggregating, and technology systems implementation. In a recent DerivSource webinar, panellists from the International Capital Markets Association (ICMA), Société Générale, BNY Mellon, and the DTCC Deriv/Serv, discussed the operations challenges of preparing for SFTR and where firms can go for help in getting ready.
The final regulatory technical standards for the European Union’s Securities Financing Transactions Regulation (SFTR), are due to be published and adopted during the second quarter of 2018. From the second quarter of 2019, banks and investment firms will be required to report securities financing transactions to authorised trade repositories (TRs). Reporting requirements for central counterparties (CCPs) and central securities depositories (CSDs) will be phased in during the third quarter of 2019, followed by UCITS, AIFs and pension funds in the last quarter of 2019, and non-financial counterparties in the first quarter of 2020, according to current proposals.
SFTR shares many commonalities with the European Market Infrastructure Regulation (EMIR) and the second iteration of the Markets in Financial Instruments Directive (MiFID II), as well as some important differences.
Aside from the obvious difference in product scope, SFTR, which covers securities finance transactions, is more closely aligned with EMIR, which covers OTC and ETD derivatives, than with MiFID, which regulates most derivatives and cash financial instruments. Both EMIR and SFTR require reporting to a TR supervised by the European Securities and Markets Authority (ESMA), whereas MiFID requires reporting to a National Competent Authority (NCA), either directly, or via an Authorised Reporting Mechanism (ARM).
When it comes to messaging standards, EMIR and MiFID both mandate the use of ISO 20022 for output, but only with SFTR does ESMA require using the messaging standard for both input and output.
As European regulations, EMIR and SFTR share a similar legal form, whereas MiFID and MiFIR are also subject to national variations with regards to implementation. Both EMIR and SFTR are focused on controlling systemic risk—whereas MiFID II is more focused on tackling market abuse, and market surveillance. Consequently, MiFID focuses on transaction reporting, while SFTR, like EMIR, requires both trade and position-level reporting.
However, when it comes to repo, the focus will likely be on trade-level reporting. “Position-level reporting for us is mainly relevant in the case of daily margining, so that will be reported on a position-level basis, but everything else will most likely be on the trade level,” says Alexander Westphal, Director in ICMA’s Market Practice and Regulatory Policy team in London. “That raises some challenges with the global aggregation of data, because the FSB requires position-level reporting. These positions have to be calculated from the trade-level reports. Overall, this is an area which still requires more clarity,” he says.
Operational challenges under SFTR
A key difference between the regulations is the number of fields market participants are required to populate in their reports. MiFID requires 65 reporting fields, EMIR 85 (or 129 depending on the institution or product). SFTR proposes a total of 153 fields or around 117 fields for a securities lending trade, and over 80 proposed reporting fields for repo transactions alone.
Inter-and intra-TR reconciliation is required on the majority of fields on an ongoing basis, with very little tolerance for error.
This is particularly challenging for firms as the securities financing world—and repos in particular—is often bilateral, with high levels of manual intervention. Other derivatives, even OTC derivatives, regulated under EMIR and MiFID, tend to have higher rates of straight-through processing (STP), and have been regulated for a longer time. Coupled with the large number of proposed fields, and the ongoing reconciliation requirement, this will be a difficult task for many institutions.
However, David Masters, Director, Operations Regulatory Reporting – Referential Data Coordinator, at Société Générale, says this can also be seen as an opportunity for regulation to drive increased automation in the securities financing industry. “For example, with repos, we can try to see how we can use affirmation to agree as many of the reportable data fields up front as possible, so we reduce the chances of the data being incorrect when we come to the reporting.”
The diverse nature of securities financing instruments and the variables that can come into play also make SFTR reporting more complex than transaction reporting under MiFID. Instruments ranging from repo, securities lending, and buy/sell backs, to margin lending, may be traded on a principal basis or through an agent, with different collateralisation methods, either bilaterally or tri-party. This poses a number of challenges, especially as firms may have a combination of different types of SFTs on their books.
“Firms should not underestimate the work required—it is huge. It’s a massive change to what they do, and how they do it, in a marketplace that is really not as well developed as the others we’ve faced so far. And yet the regulator is requesting fully-fledged, fully-scoped reporting across more than a hundred fields,” says Masters.
“Aside from the dual-sided reporting and reconciliations challenges in an environment with low levels of STP, firms also need to report lifecycle events on SFTs. Consequently, rate changes, marks, partial returns and changes to the composition of the collateral held against the SFTs all need to be reported. The mechanism within tri-party by which managers optimise collateral, means that the collateral buckets change on a daily basis,” says James Day, Head of Securities Finance for EMEA, BNY Mellon. “Solving the challenges of lifecycle reconciliation is an important focus at the moment,” he adds.
Firms will need to carefully manage their referential data architecture, including ensuring there is consistency with regards to how certain products are referred to within the organisation, and maintaining unique trade identifiers (UTIs)—whether these are provided or whether the firm needs to create them themselves, and collecting legal entity identifiers (LEIs) for all counterparties. Over a million LEIs have been registered in the course of MiFID and EMIR preparations, but firms will need to be aware of any gaps where certain participants are not yet registered, and help ensure their clients and counterparties are registered in time for the 2019 SFTR deadline, and that their LEIs remain active. Entities need to renew their LEIs well ahead of the date they are due to expire to ensure they do not lapse, according to Masters.
In the DerivSource webinar, 46% of participants said improving data management and quality was an important area for investment, while 27% said they were focused on improving trade matching—especially upstream matching—and 27% said they were investing in post-trade reconciliation.
Pros and cons of delegated reporting
Under SFTR, both counterparties must report the details of all SFTs concluded, as well as any modification or termination, to an authorised TR. As with EMIR, firms may delegate their SFTR reporting to third-party agents or their trading counterparties. And in the case of small and medium sized non-financial enterprises, this delegation is mandatory. Around half (51%) of the participants in the DerivSource webinar said they were considering delegated reporting.
With the dual-sided reporting requirements in place, it can make sense to have one counterparty fill in both reports, reducing the chance of mismatches in the reconciliation process. However, firms should note that while they outsource the task, they do not outsource the responsibility to provide accurate and timely reporting, so they will need to ensure that the reports being generated are of good quality.
Another aspect to consider is how international firms outside of the EU will be affected by the dual-sided reporting requirements under SFTR. “There are a number of firms outside of the EU that would need to provide the information to enable their clients to report. Firms need to make sure that they don’t overlook the fact that they need LEIs for these clients that are not caught under the regulation and that they have the information that is required to enable the other side of the SFT to report that correctly,” says Day.
In general, firms will be able to leverage or build on many of their preparations for EMIR when looking at SFTR. “Although the underlying products are very different, the mechanism and approach is very similar. I think that will help firms in determining whether to leverage intermediaries, and whether to report directly to a TR or not. It’s also worth remembering that while a European initiative, SFTR came out of a G20 recommendation for addressing shadow banking risks, so these or similar requirements are likely to expand beyond Europe in the future. Firms should factor that in when making decisions around potential TRs and delegated reporting,” says Valentino (Val) Wotton, Managing Director, DTCC Deriv/SERV.
Industry bodies assist with SFTR preparations
Trade Associations such as ICMA are working with regulators and the industry to clarify outstanding questions, and focus on how the rules will be implemented, and what will happen after. ICMA’s European Repo and Collateral Council (ERCC) has created a dedicated SFTR taskforce, comprising market participants, vendors and service providers, including matching engines and TRs. As part of the work of this group, ICMA launched a bilateral reconciliation exercise in June 2017, which encourages members to exchange and attempt to match data on existing trades to see where the key pain points are and where efforts need to be focused.
From the TR perspective, the DTCC is working closely with ESMA as well as the relevant industry bodies, through their SFTR working groups, on pre- and post-SFTR implementation issues and helping the industry drive post-implementation matching rates.
During a poll of participants in a recent DerivSource webinar, some 42% of participants said they had not yet started to prepare for SFTR. Firms will need to involve various departments in their preparations including Treasury and other areas, and the sooner they engage them the better.
“Firms should focus first on understanding the scope of the activity within their organisation that falls under the regulation. Once they have that visibility, they should look at the information that needs to be reported, and understand where that information can be sourced internally. If they are required to give that information to clients to meet their obligations, firms should look at the clients that are impacted by the regulation and figure out how to compile that information and provide it to them,” says Day.
“Firms should not underestimate the work required—it is huge. It’s a massive change to what they do, and how they do it, in a marketplace that is really not as well developed as the others we’ve faced so far. And yet the regulator is requesting fully-fledged, fully-scoped reporting across more than a hundred fields,” says Masters.
Missed the webinar? Watch the recording here.
