In just 18 months’ time it is very likely that Europe will be in the final stages of the adoption of the Securities Financing Transactions Regulation (SFTR). There is no doubt that the securities lending markets will not have seen anything like this before. The depth and frequency of the reporting obligation will require reporting counterparties to aggregate and collect data in new and often different ways. The SFTR will also require the full adoption of the Legal Entity Identifier (LEI) framework and for the first time securities lending transactions will be reported to a Trade Repository (TR).
The adoption of the SFTR may be seen as something of a watershed event as the European Commission (EC) is the first major regulatory block to formally adopt the recommendations of the Financial Stability Board (FSB) around the reporting and transparency of Securities Financing Transactions (SFT’s). Whilst the aims and objectives of the FSB’s recommendations are clear around the financial stability agenda some argue that the level of response from the EC is not proportional with those broad objectives and regulators run the risk of being swamped with data. As other global regulators respond to the recommendations made by the FSB the position adopted by the EC will be able to be judged in better context.
As we look more broadly at SFTR it is perhaps also appropriate to pause for a moment to consider what all of this means for institutional investors who make their securities available for lending. There will be a need for the provision of detailed information down to the LEI entity level on a trade date plus one basis. Many institutional investors in agency programmes may simply look in the direction of their agents to help with this process but as with something as complex as the SFTR it is not necessarily that straight forward. SFTR relies heavily on the broad adoption of the LEI framework. The obligation here rests with the institutional investor to obtain the necessary LEI’s which routinely have to be applied at the legal entity of the lending account. This process is relatively straight forward and although there are some costs involved this is effectively mandatory. Also many entities will already have them as part of MiFID trade reporting regime that become effective in January next year.
Another perhaps unexpected factor in the debate around the implementation of SFTR is the number of lending principals who will fall outside of the mandatory reporting obligations. Recent work undertaken here at ISLA suggests that over 60% of current outstanding loans in Europe will be coming from ‘out of scope’ lending principals and in some cases in can be much higher. For example circa 80% of Government bonds on loan in Europe come from institutions outside of Europe. These simple statistics present lenders and borrowers with some interesting challenges and questions to consider.
First, the SFTR reporting framework is built around the premises of dual sided reporting. Whilst that works well in the derivatives markets, from where the concept is borrowed, it is less effective in securities lending markets. In a typical agent lending transaction virtually all of the unique information around a trade including who a borrower has borrowed securities from in a bulk trade and where any non-cash collateral is allocated can only come from the lender. In the main therefore a borrower simply re-reports whatever the lender tells him. Although somewhat disjointed that process will work where both sides of the transaction are within the scope of the SFTR but the position is less clear where the lender in particular sits outside of the reporting regime. Institutional investors with no real obligation or incentive to provide data in the right format or within the prescribed timelines will need to be convinced especially if costs associated with things like LEI’s head in their direction.
Second, some are beginning to debate the merits of providing such vast amounts of proprietary data in Europe when other regulators appear to be adopting a slightly lighter touch approach. At the extreme this could lead to institutional investors finding the reporting requirements in Europe too onerous, especially if they don’t actually apply to them causing them to potentially rethink their securities lending strategies. We would be concerned that this could potentially lead to a loss of lending liquidity within Europe at a time when the Capital Markets Union is a priority in a post Brexit world.
As we look towards implementation in Europe the interdependency with the rest of the world is apparent. With the vast majority of loans coming from outside of Europe and many of the lending books manged by global players it is important to recognise that the SFTR cannot be seen as just a European reporting regime. Its impact is far more far reaching than that.
Andrew Dyson, Chief Executive Officer, the International Securities Lending Association.