After Mifid II swamped the industry with rules aimed at making the markets safer, European firms are now waiting for the next big surge of regulatory reporting requirements, this time aimed at securities financing desks. Implementing the final part of the Securities Financing Transactions Regulation (SFTR) is expected to be major task as firms allocate resources to meet the trade reporting obligations, and adapt to any changes that may arise as a result.
The European Securities and Markets Authority (Esma) has set out the technical standards and although they were initially expected to be adopted by the European Commission in the first half of this year, experts now suggest this will be pushed back to the third quarter. Once the green light is on, firms engaging in securities financing transactions only have one year to prepare operationally and gather the required data to fill over 150 reportable fields. This is said to be one of the biggest challenges given that at present, reportable data is both dispersed and disparate.
Alongside the reporting element, the new regulation also has the potential to disrupt some of the long-established processes in the securities lending industry.
Agency lending disclosures
An increased focus on transparency has forced the industry to consider whether the existing model for agency lending disclosure (ALD) is fit for purpose.
Under the current model, information is disclosed the day after settlement (S+1), whereas SFTR requires that data the day after the transaction has taken place (T+1). The ALD also lacks some of the information that the regulation stipulates.
“Due to the existing timing of the file and the data provided in the current ALD model, it will not provide all of the information required, or in a timely enough manner to be able to be used for SFTR purposes, unless significant changes are made,” Paul Bradford, European head of equities securities lending and repo trading at ING, said.
However, as the ALD is also used in the US, which does not fall under the scope of SFTR, there has been some push back from those who see no immediate need to change it.
“SFTR will more than likely supersede and at some point replace ALD, but it probably doesn’t make sense for that to happen at the same time as SFTR is implemented,” Bradford said.
Jamila Jeffcoate, head of agency lending for State Street Global Markets in Europe, the Middle East and Africa, also pointed out that even though the lender is required to disclose their identity by using a legal entity identifier (LEI), this only occurs after the trade has been struck.
“So, the costs incurred for the borrower are not known early enough to factor into pricing,” she explained, adding that ideally the borrower would prefer to receive LEI transparency at the point of trade to enable them to determine whether the trade is viable.
The cost burden
The costs involved in the day-to-day reporting have become a grey area. Beneficial owners could delegate reporting to agent lenders, but it remains uncertain who would pay the fees.
On the one hand, agent lenders could charge more for taking on the obligation, while on the other, beneficial owners could say that they will pull out of lending if delegated reporting isn’t offered.
Jeffcoate said: “It is expected the majority of beneficial owners will delegate the reporting function to their agent lender”.
However, another option would be for them to lend to counterparties outside of Europe that do not fall under the scope of SFTR.
“This turn of events may force more securities lending transactions off-shore but it is still too early to properly evaluate how loan volumes in the EU will be impacted,” Jeffcoate added.
Costs are also likely to have a bearing on how trades are structured and whether certain trades with minimal spread, such as general collateral (GC) borrows, are able to absorb these costs, she suggested.
Conversely Bradford suggested that it may not have a huge impact on trading.
“Once everyone has sorted out their reporting requirements it will just be a file at the end of the day so I don’t see it being a huge issue for trading desks going forward,” he said.
He added: “Where I think it may change how we trade and who we trade with will purely be down to the costs involved.”
At present, it is easy to do business with a broad range of counterparties based on revenue and credit and risk factors, without having to take into account how operationally efficient they may be.
Dean Bruyns, senior product manager for trade and transaction reporting solutions at tech firm Broadridge, observed that with SFTR in play, front office changes are however going to be quite profound.
Lenders and borrowers will be more selective about who they do business with, given that borrowing stock from a counterparty whose data isn’t of good quality will result in reconciliation problems and ultimately higher costs.
“So they are likely to be more selective in who they deal with post SFTR go-live. The additional costs and work involved when dealing with inefficient reporting counterparties could make them prohibitively expensive to deal with,” he said.
The complexity around reconciliation may also encourage some regulatory arbitrage in the short-medium term, Bruyns suggested.
“SFTR type regulations are likely to roll-out globally over time which will negate the arbitrage but some traders might take advantage of it while it lasts,” he said, explaining that EU entities may, for example, borrow from an out-of-scope US bank to make the reporting obligation single-sided.
Additionally, smaller players who do not have the budget to support full automation could perhaps turn to auto-borrowing to alleviate the additional workflow burden incurred by SFTR. This could also provide liquidity to cover a potentially smaller pool of lenders available to them post go-live, according to Bruyns.
“For the market-makers and smaller banks who do not generate revenue from stock lending and are only facilitating settlement or raising finance for their core businesses, auto-borrowing via international central securities depositories (ICSDs) could become more popular,” he said.
Simon Davies, senior consultant and SFTR expert at consultancy The Field Effect, warned that as beneficial owners start factoring in the additional reporting burden in Europe, and reassessing their lending options, there could be a knock on effect on liquidity and volumes.
“There will seemingly be an increase in volumes because the agency lenders’ booking model will change, and the industry needs to align how they are going to deal with this,” he pointed out.
Automation, on venue
One of the keys to facilitating reporting, and ensuring better quality and accuracy, would be to automate and streamline processes, Davies suggested.
“We are seeing a general trend across securities lending of an increase in the use of multilateral trading facilities (MTFs), and with regards to repo the use of MTFs is either consistent or increasing depending on data,” he said.
“This is because it helps deal with increasing volumes, and could have additional benefits around best execution under Mifid and SFTR in terms of UTIs and data sharing.”
Tom Pikett, product manager at Trax, similarly expects to see more trading move onto venues.
However, he pointed out that if a firm wants to move the majority of its trading on venue, “one of the challenges is getting the relevant counterparties to be comfortable trading on a MTF”.
“This represents a behavioural change for a portion of the securities finance market,” he added.
Given that there is already a higher degree of automation in securities lending compared to the repo market, SFTR could have a greater impact on the latter.
“In the repo market, there is a significant level of on-venue trades utilising central counterparties, which is mainly restricted to dealer-to-dealer overnight repo trades,” Pikett said, explaining that outside of these parameters, longer term or open repos tend to use existing processes which are commonly manual and outdated.
“We expect SFTR will make manual processing sufficiently difficult and costly given the large amount of data being exchanged and matching requirements,” he added.
Seizing the opportunity
Tech vendors such as Equilend and Trax, IHS Markit and Pirum have already announced partnerships to help pull together data from various sources and deliver it to the trade repository in the required format.
The drive towards leveraging vendors’ solutions to facilitate reporting requirements could result in more standardisation, which would be positive for the industry. On the other hand, the use of their services will inevitably add to the cost involved in compliance.
Bradford said: “What I am most concerned about is the cost that is inevitable in this. If you can do it all yourself then the only cost you have will be to the trade repository, but there isn’t yet clarity on how or what we are going to be charged.”
Davies however argues that “you can leverage the cost of implementing SFTR to benefit the firm through cost reduction and take advantage of the industry level changes that are likely to occur as a result”.
“When was the last time you had the opportunity to do a wholesale business model review, and look at how to change it?” he asked.
This also encourages firms to look to a more future-proof model, incorporating more efficient processes that allow them to be more flexible, agile and ready for changes that would yield benefits further down the line.
“The barometer of what is good is going to change. So whilst planning for SFTR compliance, firms should build in expected future developments and as much flexibility as possible,” Davies explained.
Another point, which is perhaps overlooked amid the focus on compliance, is that there is a benefit to having more data.
“That benefit isn’t always a tangible one,” Davies said. “But having better quality data earlier helps with better trading decisions, managing capital constraints, it gives firms more control over trading decisions, and results in fewer breaks and less risk, which is really what the objective of the regulation is.”
SFTR was Europe’s response to the Financial Stability Board’s (FSB) request for more transparency in the so-called shadow banking world, so that regulators could see where risks are building up in the market.
According to David Hiscock, senior director for market practice and regulatory policy at the
International Capital Market Association, to achieve that objective, SFTR could have focused on positions, which better reflect risk, rather than transactions.
“The authorities have however decided to go for a big bang solution – they want everything from everyone,” he said.
This approach has in turn incited collaboration and forward thinking in the industry.
“We see the landscape of service providers evolving as people work through the challenges they have and some will emerge with solutions,” Hiscock said.
According to report on SFTR challenges and how to overcome them, published in April by NEX, SFTR is also a “necessary building block in strengthening investor protection” but will require cross-industry collaboration.
“Whether or not the new regulation on SFT reporting will generate more clarity remains to be seen. But as it will become a permanent and immovable pillar of financial regulation it is essential that firms on the buy-side as well as the sell-side ensure that they are familiar with SFTR and are ready to implement it sooner rather than later,” it said.
Although the implementation of reporting under SFTR will be a big task for the industry, it is not the first and only data they must report.
The European Central Bank collects securities finance data under the money market statistical reporting introduced in 2016. Some firms may also be able to leverage expertise from their derivatives desks which are subject to similar reporting requirements under Mifid and the European Market Infrastructure Regulation.
For some, it is an opportunity to pick up more business, be that through offering reporting services or advising firms to ensure that both counterparties are compliant. For others, the cost of compliance may create a barrier to entering the European securities financing market; they may be directed elsewhere or they may stop altogether.
Although some firms are still waiting for the flag to come down before preparing for the final version of the rules, experts have urged the industry to prepare now, not only for the reporting requirements, but for the inevitable changes the new regulation will bring to the industry.