SFTR: New EU regulation set to hit securities financing and wider collateral markets
Following the global financial crisis, the FSB, the ESRB and the European Commission have instigated various initiatives aimed at looking at measures to improve the transparency and monitoring of non-bank alternative credit provision (or "shadow banking").
In an EU context this has resulted (amongst other things) in the Regulation on transparency of securities financing transactions and of reuse (the Securities Financing Transactions Regulation or SFTR1) which came into force on 12 January 2016 (subject, crucially, to various transitional provisions as set out below). However, as the European Securities and Markets Authority (ESMA) is required to produce regulatory technical standards (RTS) and implementing technical standards (ITS) specifying further detail in relation to some areas of the level 1 Regulation, we will not have clarity in these areas until the level 2 rules have been finalised.
Amongst other things, the SFTR aims to enhance transparency and enable regulators to better monitor risks by:
a) introducing reporting requirements for securities financing transactions (SFTs) (similar to those already applicable to derivatives transactions under the European Market Infrastructure Regulation (EMIR2)); and
(b) introducing limitations on the reuse of collateral (not just in the securities financing markets but also in the wider collateral markets – thus, the application of these limitations is wider in scope than to just SFTs).
Article 4 of the SFTR sets out the transaction reporting and recordkeeping requirements. The conclusion, modification or termination of an SFT must be reported to a trade repository (TR) which is registered or recognised in accordance with the SFTR.
The actual start date for transaction reporting depends on the relevant RTS relating to the reporting requirements. These RTS must be submitted by ESMA to the European Commission by 13 January 2017 and will then undergo a process of adoption by the European Commission. The reporting obligation will apply on a phased-in basis from the date which is 12, 15, 18 or 21 months after the date of entry into force of the RTS, in each case, depending on counterparty type (each such date, a Relevant Reporting Start Date). The intention behind the phase-in is that more sophisticated market participants will be required to report first.
In addition to applying to SFTs concluded on or after the Relevant Reporting Start Date, certain SFTs must be reported with retrospective effect. SFTs which were concluded before the Relevant Reporting Start Date and remain outstanding on such date must be reported within 190 days after the Relevant Reporting Start Date, if (i) the remaining maturity of such SFTs on the Relevant Reporting Start Date exceeds 180 days, or (ii) such SFTs have an open maturity and remain outstanding 180 days after the Relevant Reporting Start Date.
The reporting obligations under the SFTR are similar to those already applicable to derivatives transactions under EMIR and there is also the potential for some overlap with the reporting requirements in MiFIR.3 Notwithstanding this, the SFTR reporting requirements are distinct. The intended lack of overlap in terms of in-scope transactions is to be welcomed, however, market participants will nonetheless need to amend their existing EMIR reporting systems to cater for MiFIR and SFTR reporting requirements. This means that market participants will need systems in place to assess quickly which requirements apply to which counterparty pairings and transactions in respect of all three regulations and will need to work to differing timings for implementation.
Similar to the recordkeeping requirements in EMIR and MiFIR, counterparties subject to the SFTR are required to keep a record of any SFT that they have concluded, modified or terminated for at least five years following the termination of a relevant transaction. The recordkeeping requirements do not have the benefit of the delayed implementation and applied from 12 January 2015 and so market participants need to ensure they have the appropriate processes in place to facilitate this or risk being in breach of regulatory requirements.
Article 15 of the SFTR sets out restrictions on the reuse of financial instruments received as collateral under a collateral arrangement. "Collateral arrangement" is defined by reference to a security financial collateral arrangement or a title transfer financial collateral arrangement, in each case, as defined in the Financial Collateral Directive.4 Under Article 15, a right of reuse of financial instruments received as collateral is subject to at least both the following conditions: (a) risks and consequences have been communicated in writing; and (b) prior express consent of the providing counterparty has been granted. The exercise of a right of reuse is subject to at least both the following conditions: (a) reuse is undertaken in accordance with the terms specified in the relevant collateral arrangement; and (b) financial instruments are transferred from the account of the providing counterparty.
The restrictions on reuse of collateral apply from 13 July 2016 and shall apply to collateral arrangements existing as of such date as well as to new collateral arrangements.
The restrictions on collateral reuse will pose a number of challenges, particularly given the tight timeframe before implementation. Market participants will need to consider which transactions (including existing transactions) fall within scope, how this will be monitored in respect of new transactions and how documentation may need to be amended (or introduced) to satisfy the new requirements. Industry initiatives are currently underway with the aim of producing standard disclosure wording.
There may also be a number of issues raised in respect of how the extra-territorial aspects of the SFTR will apply. Experience on EMIR has proven that application to third country entities can be unclear and potentially problematic.
Please contact us for a copy of our detailed bulletin on SFTR.
1. Regulation (EU) 2015/2365 of the
European Parliament and of the
Council of 25 November 2015 on
transparency of securities financing
transactions and of reuse and
amending Regulation (EU) No
2. Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories
3. Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012.
4. Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements.