Just as the smoke has started to clear from the implementation of MiFID II, the European Commission looks set to greenlight the Securities Financing Transaction Regulation, writes NEX Optimisation’s Suzannah Cotterell.
When Europe’s MiFID II regulations came into force in January this year, they represented a sweeping market reform that impacted not only European companies but also their overseas counterparties.
The required analysis and implementation created major headaches for any Australian sell-side or buy-side firm with a European branch or transacting with European partners.
Just as the smoke has started to clear, the European Commission looks set to green-light another round of regulations.
The new regulations will have a similar degree of “third country” impact, heaping significant reporting requirements on Australian firms engaging in securities financing relationships with European counterparties.
The upcoming Securities Financing Transaction Regulation (SFTR) will require participants in some of the world’s biggest financial markets to submit up to 153 data fields within a day of trading.
This is a heavier lift than both MiFID II and the ostensibly more closely related EMIR regulations.
What is SFTR and what is it for?
In the context of the wider global response to the global financial crisis, SFTR is the next step in a process that started by addressing bank capital and enhancing governance standards (EMIR) and then moved on to safeguarding investors (MiFID II).
Subsequently, SFTR will impose oversight on the as-yet unregulated “shadow banking” sector.
Thus, SFTR aims to address the financial counterparties active in Europe’s massive repo and securities lending markets. As of the end of 2016, the repo market alone amounted to €5.6 trillion, or roughly 13 per cent of the European Union’s banking assets.
Securities lending or borrowing – the lifeblood of the hedge fund industry – makes up another €1.9 trillion of the securities financing transaction (SFT) market. Other SFT categories include commodities lending or borrowing, buy-back/sell-back, margin lending and total returns.
In relative terms, the shadow banking system in Europe is thought to be about half the size of regulated banking markets.
It is therefore unsurprising that SFTs are now the object of Europe’s next major regulation. Just as European Securities Market Association (ESMA) Chair Steven Maijoor said recently: “Bringing transparency and oversight into the multi-trillion-euro market of securities financing transactions is an important step in closing a regulatory gap.
“It is pivotal for financial stability that the risks associated with non-bank alternative credit provision are properly addressed.”
Who does SFTR apply to?
Like current EU regulations MiFID II and EMIR, there is a significant extraterritoriality element to SFTR. It will cover EU counterparties, non-EU branches of EU firms, and the EU branches of “third country” firms such as Australian banks.
As with MiFIR, it’s not enough for non-European firms to assume that they are not included. In fact, all firms engaging in SFTs touching Europe or European collateral should be conducting an analysis of their business against the draft Regulatory Technical Standards (RTS) now.
To give some examples, fund managers that are engaging in securities financing trades with, or sourcing collateral from a European counterparty are likely to fall in scope.
Australian firms that transact with European entities, but are not directly within scope will need to provide their in-scope counterparties with additional information needed to comply.
There are several institution types, agreements and edge cases which will be caught by reporting requirements, so careful scrutiny of the rules and trading activity is imperative.
What’s the big deal?
Put simply, SFTR creates a further set of challenges for non-EU firms engaging with Europe. As highlighted above, the moment you transact with someone in the EU you will become liable for the required daily reporting requirements that include 153 data fields. This compares to 129 data points for the related EMIR regulation.
And the clock is ticking rapidly for those in scope. Last month, the European Commission announced that the final rules are expected to be published by the end of 2018.
Given that the first phase of firms, including investment firms and credit institutions, will be required to start reporting 12 months after publication, reporting would start in late 2019 or early 2020. with the regulations coming into effect.
Other subsets of counterparties are scheduled to begin reporting at three-monthly intervals thereafter.
Ultimately, the degree of transparency achieved by reporting on SFTs will take a few years to manifest.
But as SFTR becomes a permanent and immovable pillar of financial regulation in Europe, it is essential that Australian firms, buy-side and sell-side, ensure that they are familiar with the regulation and are ready to implement it sooner rather than later if applicable.
All market participants need to act now to ensure that they can identify, access and work with the data required to comply with this regulation.
Suzannah Cotterell is a business development manager at NEX Optimisation.