Written by Maria de los Angeles Periñan Herrera, Consultant
The regulation on the SFT has been published in the Official Journal of the European Union on 23 December 2015. However, the Regulatory and Implementing Technical Standards, which provided much needed clarification on the reporting of SFTs, were only approved in March 2019. As regards the timing of implementation for the counterparties subject to the reporting obligation, SFTR has adopted a phased-in approach. The investment firms should have started reporting 12 months after the publication (mid-April 2020), nevertheless due to the pandemic the market participants were allowed more time to prepare, and the reporting was delayed by another 3 months to finally start in July of last year.
The phased-in approach (every three months) required first the reporting for credit institutions, investment firms, CCPs and CSDs, followed by other financial counterparties (Insurance, UCITS, ManCos, AIFMs) and finally in January 2021 the start of reporting for non-financial counterparties.
The regulation was adopted to provide the regulators and the investors with more transparent view on the securities financing market and to promote a better account of the risk posed by the interconnectedness in the market via short term collateralized funding and the re use of the collateral.
Although it has already been a year since the reporting obligation has begun, the main challenge for market participants persists to be to gather all the information required to populate all 155 fields, this includes information about the transaction characteristics, specificities of the collateral, margins and calculations required for collateral reuse. This is a slightly greater amount of information than requested in the 133 fields of the derivatives’ regulation EMIR. On top of the greater scope, there are other differences that include the use of the XML schema ISO20022 (to communicate the data to the trade repository) and the mandatory delegation, where the financial institution becomes accountable for the reporting on behalf of their non-financial counterparties, which are however still responsible for providing all the relevant information. The financial institution shall send its report to the trade repository to be compliant. This show that familiarity with the EMIR reporting helps but does not necessarily mean an easy path towards SFTR reporting success.
The report of the transaction is divided in two parts, the first part identifies the parties of the contract and defines who is responsible for reporting. However, the greater challenge is in providing the information requested on the second part where it is necessary to fill detailed data on the loan and collateral. There are around 99 fields which are either mandatory, conditional, or optional depending on the type of transaction to be reported. It is important to be careful and understand the structure of the report, the information requested first is related to the loan, the information requested later is required to provide the data on the collateral. However, in both sections, the field names are similar, so it is important to take caution to make sure that the data is sent in the correct order.
One of our first client for the SFTR reporting was particularly distressed by gathering and compiling all the information required under the technical standards as it was not possible to obtain everything from a single source. There was also a notable confusion as regards providing the data about the collateral, particularly when reporting securities lending. This situation mainly presented itself when the collateral involved in the transaction was not cash but another security, in such cases it is required to provide all the information about the security and the information on the security received as collateral. As mentioned, it is imperative to understand the order in the report to be able to differentiate between data on the security lent and the data on the received collateral. In SFTR, the securities lending requires more mandatory data.
There are other two XMLs messages that need to be provided if the transaction has been cleared (traded via CCP) or if the collateral is reused. This could also present a challenge as they increase the number of reportable fields up to all 155. The information required on margins for cleared transactions is likely already gathered to comply with other regulations and should therefore pose no additional effort to acquire. However, the information about collateral reuse will be more challenging as it is a new requirement containing a key information of the risk of the SFT and shall be calculated to allow its monitoring by the competent authorities.
Some examples of the risk involved in collateral reuse are the contribution to the increasing leverage of market participants, the interconnection of transaction chains with the same collateral and the stress that can be produced to market stability if there is a drop in value of the securities involved as collateral. Due to this and based on the Financial Stability Board metrics, market participants entering short term non-cash collateralized funding shall report the extent and details of their collateral reuse, they should provide the exact measure if they can or an approximate measure that can be calculated with the formula provided in their documentation.
According to FSB documentation, market participants highlighted that it will be extremely difficult to extract the information necessary to compute the exact measure as they don’t generally distinguish between own securities or securities originated from another collateralized transaction when posting collateral. This said, the easiest way to proceed when reporting will be by using the formula that approximates the amount:
Source: FSB – Non-Cash Collateral re-use measures and Metrics.
The intuition behind this FSB formula is that the collateral reused is a proportion of the collateral that an institution has received as eligible for reuse compared with its own assets. The formula also implicitly assumes that the probability of a security being posted as collateral is independent of weather it comes from its own assets or another collateralized transaction.
It is important to note that the reporting obligation only applies to SFTs, the collateral securities posted or received from other transactions should not be considered. When reporting, market participants are supposed to only provide the estimate that results from the application of the formula at ISIN level. This can make the calculation more difficult as it must be separately treated for each security.
To conclude, it is possible to say that the reporting of Securities Financing transactions presents a higher degree of difficulty for market participants than similar regulations such as EMIR, not only because there is a slightly greater number of fields and details to be reported but also due to the new requirements related to the reuse of collateral. Although the regulation has been out for quite a long time compared to the timing of the reporting implementation, it can still take some time for the market participants to adapt and gather all the new information requested, also it can be more challenging for non-financial institutions that do not have the infrastructure and specialized workforce to dedicate to this matter.