Assessing the key talking points from ESMA’s consultation on SFTR guidelines

The latest consultation paper from European regulators represents one of the last opportunities for changes in the draft guidelines for the Securities Financing Transactions Regulation. Jonathan Watkins breaks down the key points.

The European Securities and Markets Authority’s (ESMA) public consultation on draft guidelines for the incoming Securities Financing Transactions Regulation (SFTR) has called for input from market participants on a number of crucial proposals.

Responses to the landmark regulation aimed at increasing transparency into securities financing transactions such as margin lending and repo need to be filed by 29 July 2019, leaving market participants with a relatively short time-frame to relay their thoughts to the regulator.

The consultation includes 85 questions across 178 pages. Below are some of the key talking points from the consultation:

Backloading: The backloading requirement, which could require action on old transactions, as well as new ones, still needs some clarification.

“ESMA has asked participants to consider the pros and cons of reporting all transactions from reporting start date, including both new and open SFTs as opposed to just reporting new transactions and a subset of the open transactions based on their specific maturity dates,” explained Nicklas Nilsson, business analyst at Compliance Solutions Strategies (CSS).

The industry will be hoping the requirement isn’t implemented on day one of the application of the obligation, although some sources explained they get the feeling it’s being brought forward.

Seb Malik, head of financial law at Market Finreg, noted that what ESMA is proposing is “precisely what I’ve been advising my clients all along and have been warning against previous industry attempts to ignore law and just report all on go-live.”

Collateral re-use: Targeting collateral re-use is one of the main pillars of the regulation which has been deemed to give rise to financial stability risks through complex chains. The new rules require information from the collateral receiver on the risks and consequences that may be involved when granting consent to a right of use of collateral provided under a collateral arrangement.

“Clarification regarding approaches to collateral reporting and re-use examples is also a big portion of the document where they clarify that the reinvestment formula does not apply to cash reuse which hopefully will make things easier, if reuse of cash is in scope for the reporting entity,” said Scott Brown, business development manager at Pirum Systems.

Nilsson added that the consultation included indication that where a non-financial counterparty receives mandatory delegated reporting from more than one financial counterparty, each financial counterpart can submit a separate reuse/reinvestment report on behalf of the non-financial counterparty. It does not, however, directly mention whether the same applies to voluntary delegation, but would suggest it will be technically possible.

With the formula applying to securities collateral, Malik also raised the issue of whether entities have to track their inventory of that security.

“Example: if Bank ABC owns 500 in security A, receives a further 1,000 in security A as collateral from a reverse repo, and uses 600 of security A as collateral to borrow another security, the estimated re-use that should be reported by Bank ABC for security A is: [(1,000)/(1,000+500)]*600=400,” wrote Malik in a briefing note.

Non-reportable transactions: Within ESMA’s general principles in the consultation, the regulator highlights ‘reportables’, with a number of processes now being listed as non-reportable. These include T2S auto-collateralisarion and intraday credit or overdraft resulting from fails-curing transactions, which the regulator said do not fall under the definition of SFT and therefore should not be reported. 

“They have listened to some of the market views, especially regarding fails-curing for intraday credit and other specific scenarios,” added Brown.

LEIs/UTIs: Participants must use Legal Entity Identifiers (LEIs) to identify their counterparts along with a number of other parties involved in the securities financing transaction, along with a Unique Transaction Identifier (UTI) to their trade repository.

ESMA acknowledged the problem markets will have with issuer LEI and highlighted the work GLEIF/ANNA are making to publish a new database with LEI/ISIN-mapping. “This is also one of the points where ESMA seeks further guidance regarding volume where either LEI or ISIN is not available,” said Brown. “The other issue where ESMA seek further guidance themselves is around UTIs; there are clarifications on standard procedures around CCP trades and generation on renewal, but I think the market will still need some more guidance around UTI generation and sharing – there will be some iterations here.”

Validation rules:  One of the main changes, according to Brown, is the change from optional to mandatory for the field master agreement – which sets the rights and obligations of the parties – in the validation rules. “This is very important as it is one of the four fields needed for pairing at the trade repository side,” said Brown.

Effective date – ESMA said that in order to provide authorities with a comprehensive snapshot of the risks to financial stability, counterparties should report only the modifications that have taken place. Modifications that are agreed but have not taken place should not be reported until the actual modification takes place. This will allow authorities, when analysing the data contained in the trade state reports provided by trade repositories, to know what the existing risks from outstanding SFTs are, rather than the potential ones.

Non-financial counterparties: Indication that an EU-domiciled non-financial counterparty would normally receive delegated reporting from their financial counterpart, but will have to fulfil their own reporting obligation if the FC is non-EU domiciled.

Reverse securities lending: There is a question for respondents on whether cash-driven securities loans should be reported using the SBL, margin lending or repo reporting template.

Non-EU entities with EU branches: There are some clarifications regarding branches and the minimum requirements for reporting, including that either the decision maker or executing trader under branch supervision is enough to bring it in scope for SFTR. This might be something that some of the non-EU entities with EU branches previously have overlooked, explained Brown.