Evaluating yesterday’s SFTR challenges today
03 July 2020
Cappitech reviews how far the market has come in tackling the key SFTR challenges flagged in its 2019 survey
Image: Jacob Lund/shutterstock.com
In September 2019, in preparation for the Íø±¬³Ô¹Ï Financing Transactions Regulation (SFTR), Cappitech conducted a survey on the new regulation with Kaizen Reporting providing feedback on the findings.
The survey focused on preparing for SFTR and included sections on identifying pain points, effects of SFTR on the business and breakdowns of products transacted falling under its scope. With SFTR going live now in July for most banks, brokers and central counterparties, and hitting the buyside in October, we wanted to review where the industry is at compared to survey feedback in September.
Reuse reporting and operational difficulties
Within the survey was a section where respondents could list their biggest ‘question marks’ of their SFTR preparation (See Figure 1, overleaf). Not surprisingly, topping the list of challenges was complying with unique transaction identifiers matching, of which 54.8 percent of respondents mentioned it. Coming in number two was compliance around reporting of reuse obligation. Overall, among those surveyed, 44.1 percent included ‘defining reuse obligations’ as the main challenge.
Under SFTR, reporting of reuse is required when a security used for collateral is subsequently being reused for another SFT. Beyond the requirement of tracking the receiving and giving of collateral, an added complexity of reuse reporting is adjusting for a firm’s existing assets they owned outright, excluding unused collateral that can be reused as well as splitting reports by ISIN.
Due to the complexities, as we near go-live, reuse continues to be an area of concern. There are two main problems being encountered. One is related to properly providing full asset details for reuse calculation estimates. The second is compliance of reuse obligations among the buy side.
Capturing 360°
To support SFTR, many firms are working with third-party tools to assist with capturing SFT details, enrichment of regulatory fields and ISO 20022 XML formatting and submissions of reports to a repository. These products can greatly increase the efficiency of day-to-day submission of new SFT reports and collateral and valuation updates.
In cases where received collateral is marked available for reuse and existing on another transaction as being lent out, a reuse calculation can be made on that product ISIN. However, simply looking at SFT details for reuse calculations excludes the effects of an investment firm’s existing ownership of the loaned collateral.
As such, firms are realising that to properly report reuse fields under SFTR means capturing and sharing collateral ownership details with their external vendor. Alternatively, while counterparty, loan and collateral details are being created through external firms, reuse reports may need to be managed internally.
Reuse and delegation
Another area of challenges that continue under reuse obligations is by who and how it is reported when delegated reporting is being provided. While not expected to be as widely available as it is under the European Market Infrastrastrucutre Regulation (EMIR), a number of sell-side firms and agent lenders are providing delegated reporting services for SFTR.
For sell-side firms reporting their leg of an SFT, providing delegation to their clients is a natural extension of services they can provide. However, where things get tricky is in regard to reuse reports of which a bank or broker doesn’t have exposure to their client’s reuse of collateral or external holdings of owned products needed for calculations.
The bottom line is that firms taking advantage of delegated reporting need to be aware that under SFTR there is a very good chance they will need to manage their own submissions of reuse details.
Will SFTR disrupt the SFT industry?
Taking into account the challenges of complying under SFTR, costs associated with the regulation and potential disruption of available collateral for SFTs for products where ISINs and the legal entity identifier (LEI) of the issuer don’t exist, in the 2019 survey, we asked whether SFTR will affect their company’s expected transacting in SFTs.
With 23.2 percent of respondents claiming the new regulation will impact their business (see Figure 2, overleaf), and nearly 50 percent unsure, it revealed that SFTR is set to shake up who are the market participants for SFTs, such as repos and securities lending.
Costs of compliance and time
Heading the concerns of SFTR is the costs associated with complying under SFTR. For many buy-side firms and small banks, SFTs are an opportunistic product to generate added alpha by lending unused assets. However, they may not be a core part of their investment thesis. Thereby, complying with SFTR means evaluating the costs expected to comply with the regulation versus gains of transacting in securities lending and repos.
Beyond financial costs, time involved with supporting the regulation has become a bigger issue due to COVID-19. Even after the European Íø±¬³Ô¹Ï and Markets Authority’s (ESMA) delay of phase one to July, a number of firms had hoped for a greater delay for SFTR going live.
Initial impact
In the lead-up to SFTR going live, at Cappitech, we have seen firms pause their new repo business in anticipation of the new regulation. Often cited is the desire to have more time to prepare due to COVID-19 challenges drawing time to other projects. In addition, companies, including those impacted by the July go-live date taking a ‘wait-and-see’ approach to evaluate how their peers are handling SFTR and delegated reporting alternatives that could assist them.
On the security lending side, in a recent panel hosted by IHS Markit and including representation from representatives from the International Íø±¬³Ô¹Ï Lending Association (ISLA), agent lenders and a major bank, it was asked if they were aware of buy-side firms exiting lending due to SFTR. The consensus among panellists was that they weren’t seeing an exodus of lenders due to the regulation. However, with SFTR further out for the buy side, and many companies just entering the preparation stage, it is worth keeping an eye on how the regulation will ultimately impact their securities lending when the October go-live for them comes into effect.
Gaps in LEIs of an issuer
Included under SFTR is a new reporting field of LEI of the issuer. Included under the securities and collateral portion of the report, LEI of the issuer doesn’t exist under either EMIR or MiFID II transaction reporting. In regards to SFTR, collateral reported without an LEI of issuer won’t pass validations.
In a September 2019 report from ISLA found that around 34 percent of assets managed by custodial banks didn’t have an issuer LEI required by SFTR. The main challenge has been among non-EU issuers. But even within the EU, figures in 2019 were far from 100 percent coverage of LEIs.
In response, ESMA provided a 12-month relief of validations on LEI of Issuers from third-party countries. In addition, ESMA has collaborated with the Association of National Numbering Agencies and local national competent authorities to raise awareness of among companies to register LEI.
As a result, recent estimates from industry participants have pointed to higher levels of LEI issuer rates being found. Nonetheless, gaps among EU issuers do exist and are expected to continue to be a problem at go-live.
Among data compiled by IHS Markit in mid-May and reviewing ISINs where LEI of an issuer is available, Ireland continues to lag other EU countries. In addition, following the 12-month relief for third-party countries, collateral and securities of any non-EU issuers without an LEI will trigger rejected messages.
Missing LEI of issuer vs percent of lendable values, source IHS Markit
This all poses a question on how firms will deal with these products. Do you suspend transacting in SFTs where LEI of issuer field is unavailable? Or, do you continue dealing with them?
If you do continue, should a report for these SFTs be submitted with the knowledge that it won’t pass validations? Or should they be held back and back reported when a LEI becomes available?
Operationally, how firms and their counterparties answer the question will ultimately impact their future SFT activity.
The survey focused on preparing for SFTR and included sections on identifying pain points, effects of SFTR on the business and breakdowns of products transacted falling under its scope. With SFTR going live now in July for most banks, brokers and central counterparties, and hitting the buyside in October, we wanted to review where the industry is at compared to survey feedback in September.
Reuse reporting and operational difficulties
Within the survey was a section where respondents could list their biggest ‘question marks’ of their SFTR preparation (See Figure 1, overleaf). Not surprisingly, topping the list of challenges was complying with unique transaction identifiers matching, of which 54.8 percent of respondents mentioned it. Coming in number two was compliance around reporting of reuse obligation. Overall, among those surveyed, 44.1 percent included ‘defining reuse obligations’ as the main challenge.
Under SFTR, reporting of reuse is required when a security used for collateral is subsequently being reused for another SFT. Beyond the requirement of tracking the receiving and giving of collateral, an added complexity of reuse reporting is adjusting for a firm’s existing assets they owned outright, excluding unused collateral that can be reused as well as splitting reports by ISIN.
Due to the complexities, as we near go-live, reuse continues to be an area of concern. There are two main problems being encountered. One is related to properly providing full asset details for reuse calculation estimates. The second is compliance of reuse obligations among the buy side.
Capturing 360°
To support SFTR, many firms are working with third-party tools to assist with capturing SFT details, enrichment of regulatory fields and ISO 20022 XML formatting and submissions of reports to a repository. These products can greatly increase the efficiency of day-to-day submission of new SFT reports and collateral and valuation updates.
In cases where received collateral is marked available for reuse and existing on another transaction as being lent out, a reuse calculation can be made on that product ISIN. However, simply looking at SFT details for reuse calculations excludes the effects of an investment firm’s existing ownership of the loaned collateral.
As such, firms are realising that to properly report reuse fields under SFTR means capturing and sharing collateral ownership details with their external vendor. Alternatively, while counterparty, loan and collateral details are being created through external firms, reuse reports may need to be managed internally.
Reuse and delegation
Another area of challenges that continue under reuse obligations is by who and how it is reported when delegated reporting is being provided. While not expected to be as widely available as it is under the European Market Infrastrastrucutre Regulation (EMIR), a number of sell-side firms and agent lenders are providing delegated reporting services for SFTR.
For sell-side firms reporting their leg of an SFT, providing delegation to their clients is a natural extension of services they can provide. However, where things get tricky is in regard to reuse reports of which a bank or broker doesn’t have exposure to their client’s reuse of collateral or external holdings of owned products needed for calculations.
The bottom line is that firms taking advantage of delegated reporting need to be aware that under SFTR there is a very good chance they will need to manage their own submissions of reuse details.
Will SFTR disrupt the SFT industry?
Taking into account the challenges of complying under SFTR, costs associated with the regulation and potential disruption of available collateral for SFTs for products where ISINs and the legal entity identifier (LEI) of the issuer don’t exist, in the 2019 survey, we asked whether SFTR will affect their company’s expected transacting in SFTs.
With 23.2 percent of respondents claiming the new regulation will impact their business (see Figure 2, overleaf), and nearly 50 percent unsure, it revealed that SFTR is set to shake up who are the market participants for SFTs, such as repos and securities lending.
Costs of compliance and time
Heading the concerns of SFTR is the costs associated with complying under SFTR. For many buy-side firms and small banks, SFTs are an opportunistic product to generate added alpha by lending unused assets. However, they may not be a core part of their investment thesis. Thereby, complying with SFTR means evaluating the costs expected to comply with the regulation versus gains of transacting in securities lending and repos.
Beyond financial costs, time involved with supporting the regulation has become a bigger issue due to COVID-19. Even after the European Íø±¬³Ô¹Ï and Markets Authority’s (ESMA) delay of phase one to July, a number of firms had hoped for a greater delay for SFTR going live.
Initial impact
In the lead-up to SFTR going live, at Cappitech, we have seen firms pause their new repo business in anticipation of the new regulation. Often cited is the desire to have more time to prepare due to COVID-19 challenges drawing time to other projects. In addition, companies, including those impacted by the July go-live date taking a ‘wait-and-see’ approach to evaluate how their peers are handling SFTR and delegated reporting alternatives that could assist them.
On the security lending side, in a recent panel hosted by IHS Markit and including representation from representatives from the International Íø±¬³Ô¹Ï Lending Association (ISLA), agent lenders and a major bank, it was asked if they were aware of buy-side firms exiting lending due to SFTR. The consensus among panellists was that they weren’t seeing an exodus of lenders due to the regulation. However, with SFTR further out for the buy side, and many companies just entering the preparation stage, it is worth keeping an eye on how the regulation will ultimately impact their securities lending when the October go-live for them comes into effect.
Gaps in LEIs of an issuer
Included under SFTR is a new reporting field of LEI of the issuer. Included under the securities and collateral portion of the report, LEI of the issuer doesn’t exist under either EMIR or MiFID II transaction reporting. In regards to SFTR, collateral reported without an LEI of issuer won’t pass validations.
In a September 2019 report from ISLA found that around 34 percent of assets managed by custodial banks didn’t have an issuer LEI required by SFTR. The main challenge has been among non-EU issuers. But even within the EU, figures in 2019 were far from 100 percent coverage of LEIs.
In response, ESMA provided a 12-month relief of validations on LEI of Issuers from third-party countries. In addition, ESMA has collaborated with the Association of National Numbering Agencies and local national competent authorities to raise awareness of among companies to register LEI.
As a result, recent estimates from industry participants have pointed to higher levels of LEI issuer rates being found. Nonetheless, gaps among EU issuers do exist and are expected to continue to be a problem at go-live.
Among data compiled by IHS Markit in mid-May and reviewing ISINs where LEI of an issuer is available, Ireland continues to lag other EU countries. In addition, following the 12-month relief for third-party countries, collateral and securities of any non-EU issuers without an LEI will trigger rejected messages.
Missing LEI of issuer vs percent of lendable values, source IHS Markit
This all poses a question on how firms will deal with these products. Do you suspend transacting in SFTs where LEI of issuer field is unavailable? Or, do you continue dealing with them?
If you do continue, should a report for these SFTs be submitted with the knowledge that it won’t pass validations? Or should they be held back and back reported when a LEI becomes available?
Operationally, how firms and their counterparties answer the question will ultimately impact their future SFT activity.
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