The journey to SFTR transaction reporting compliance
Firms with MiFIR and EMIR reporting obligations can leverage their existing infrastructure and vendor experience.
Where does the industry stand?
The adoption of Level 2 measures is currently delayed and expected to be approved between Q1 and Q2 2018 for a phased go-live beginning 12 months after i.e. in Q2/Q3 2019.
In order for firms with an SFTR requirement to meet the deadline, the first compliance phase which includes design, build and test of the infrastructures should begin in second half of 2018. This will impact the workload of the industry to perform the impact analysis and start implementing efficient operating models to take advantage of the opportunities provided by SFTR.
The industry was committed and worked very hard to meet the 3rd January 2018 deadline for the go-live of MiFID II. It is evident now that market participants need to analyse the potential impact across firms in terms of resources and budget to be compliant ahead of SFTR transaction reporting go-live in mid 2019.
At the current stage, many firms are considering whether to continue deployment of resources till completion of MiFID II or begin reallocating resources to build and implement operation models and infrastructure for SFTR.
This uncertainty might have a detrimental effect on the success of the aforementioned regulation. It is quite evident that SFTR is more than a simple trade reporting practice and impacts a wide-range of investment firms in areas such as businesses processes, controls, operations, IT systems and compliance. It is noteworthy that effort and costs will vary depending on the extent of system integration, the size of the firm and the transaction volumes. Further, challenges impacting the business model are the UTI generation, the reporting obligation to the TRs and, finally, the reconciliation process. Therefore, the industry needs to be prepared to tackle this objective rather than take a “wait-and-see” approach.
Following the footsteps of EMIR
From a technical standpoint, similar to the European Market Infrastructure Regulation (“EMIR”), SFTR includes two-sided reporting. This will affect both financial and non-financial institutions engaging in SFTs and will require them to report details of their transactions. This requirement will be phased-in according to the following timeline:
- Phase 1 - Investment firms and credit institutions (Day 1)
- Phase 2 - CCPs and CSDs (After 3 months)
- Phase 3 - Insurance, pension funds, AIFs and UCITS (After 6 months
- Phase 4 - NFCs (After 9 months)
The main SFTR’s cornerstones are the following:
Disclosure of information
UCITS are obliged to specify the SFTs which funds are permitted to use and include a clear statement of which of those are used. The following information must be included in the UCITS prospectus:
- Description and rationale of the SFTs/TRSs used.
- Criteria to select the counterparty, such as credit rating and legal status.
- Collateral description with particular reference to asset types, issuer, diversification and maturity.
- Description of risks of SFTs/TRSs and collateral management.
- Collateral valuation methodology.
- Description of any restriction.
- Overall data for each SFT.
The counterparties involved in SFTR have the right to reuse financial instruments received as collateral if the following conditions are satisfied:
- Reuse in accordance with terms
- Express consent
- Duly informed in writing
- Transfer from account
On the reporting side, the regulation is structurally identical to EMIR. They both require counterparties to report the details of any lifecycle event on a T+1 basis timely fashion. Nevertheless, counterparties to an SFT will be required to keep record of the transactions that have concluded, been modified or terminated for at least five years following the termination of the trade, as is currently required under EMIR. Trade repositories will apply a 2-way key (LEI and UTI) regardless of whether or not both counterparties to each SFTR contract have reported to the given trade repository.
In terms of reporting format, in 2017, ESMA released the SFTR final report, specifying the format and frequency of the report. The novelty is represented by requirement also on the counterparties’ side to report to TRs using the ISO 20022 standard. The final target is to provide to the industry a single standardisation approach which will ensure open and transparent market’s practices.
How is SFTR different from other regulations?
What is very interesting from a regulatory perspective is the introduction for the first time of the extraterritoriality reporting requirement. The proposed regulation would cover SFTs conducted by any firm established in the EU, regardless of where the individual branch is. Furthermore, SFTR represents a significant move towards enhanced transparency in securities lending market and risk reduction from shadow banking. However, from a regulatory standpoint, the market participants will face the following challenges once the regulation is going-live:
- The collateral re-use practice can lead to complex collateral chains, especially referring to situations where: (i) there is an extensive rehypothecation, so the same collateral will need to be reported several times; (ii) where pools of collateral are used against multiple trades, there will be difficulty allocating each element of the collateral against a specific transaction; (iii) Finally, a default on one transaction can cause a domino effect with other counterparties defaulting on their respective SFTs if the same collateral has been used in all of these.
- Reconciliation: the process requires both counterparties of the trade to provide a UTI if they are in scope. However, in some cases such as CCPs, the industry is wondering who will generate the UTI for cleared trades considering that CCPs will enter into SFTR just in Phase 2. In addition, further clarity is required in situations whereby after reporting to CCPs, the transaction is subsequently novated. The industry is keen to know whether the different UTIs should be reported to the CCP by the counterparties.
- Counterparties in scope: SFTR will cover EU counterparties, non-EU branches of EU firms and EU branches of third country firms. The market participants have concerns regarding the involvement of non-EU counterparties in the reporting chain. Indeed, those may be impacted when they trade in STFs, as the reporting entities will require certain information to fulfil their reporting obligations, for instance, the LEI of their counterparty and matching UTIs.
Following the implementation of EMIR, lessons were learned. Before the go-live of EMIR many market participants decided to take a wait and see approach and, as result, most of them were not prepared. This turned into additional compliance and operational costs.
In addition, the most important lesson learned from EMIR relates to the industry preparation to deal with continuously changing regulatory requirements and new reporting regimes. For instance, EMIR has been amended several times since its introduction in 2012. During this evolutionary period, new regulations, such as Benchmark, Short-selling and MiFID II transaction reporting entered into force.
Preparing for the new reporting regime will provide a huge benefit not only from the regulatory standpoint in terms of transparency but also efficiency and cost-minimisation. Indeed, the industry will get the chance to have access to a more data granularity and business intelligence. The regulators hope that this will dramatically improve the decision-making process resulting in a better business outcomes. The SFTR text is just one step in a continuously changing regulatory landscape and it is essential that the industry integrates the rules prescribed by the Regulator to increase transparency and integrity of the market.
In conclusion, the nuances of SFTR highlights the need to pick a TR with advanced data quality tools as regulators will be looking at rejection and matching rates. The onus is on firms to start putting their SFTR delivery team in place in other to fully assess the project requirement ahead of time. Firms with MiFIR and EMIR reporting obligations can leverage their existing infrastructure and vendor experience. Finally, the industry is in the information gathering stage therefore, firms can benefit from being part of industry groups, attending industry events and joining SFTR conversations.