When the Financial Stability Board (FSB) published its guidelines to national and regional regulators to encourage greater oversight into financial markets, even they couldn’t foresee the deluge of rules and compliance requirements those regulators would begin to craft.
In Europe, the most onerous regimes constructed by the European Securities and Markets Authority (Esma) – European Market Infrastructure Regulation (Emir) and the second Markets in Financial Instruments Directive (Mifid II) – have created a wave of change within organisations, and reinvented the compliance and reporting functions. Now, with the Securities Financing Transactions Regulation (SFTR) due to go live in 2019, those in the market are bracing themselves for a volume of trade reporting unimaginable in the pre-crisis world.
In a bid to gain insight into systematic risk of the securities lending and repo markets, the European Commission first published an outline of SFTR in January 2016. Broadly speaking, the regulation will require firms to report details on their securities financing transactions through trade repositories, but in terms of the amount of data required, SFTR’s 153 data fields dwarf both Emir (85) and Mifid II (65).
“Esma has gone way off the other end of the scale in terms of the FSB’s requirements: they want high frequency, high complexity, they’ve gone right into the granular – as is their right,” says David Lewis, senior director, FIS. “They’ve asked for an enormous amount of data. Particularly when you compare against what the FSB actually want.”
Among the requirements, firms must report who they are lending which asset to, the value of the transaction, and other largely expected pieces of information. But Esma has requested insights into the legal agreement shaping the deal, when it was signed, and a host of other issues relating to collateral. More complex is the fact that the regime requires dual-sided reporting, where pairing and matching will raise issues.
Its not uncommon for two entities to report to different trade repositories. Pairing occurs when the trade repositories align the transaction’s unique trade identifier (UTI) in order to confirm that trade. If there’s a difference in how that’s been reported by either entity, the trade information must be corrected. Within matching, both firms are required to report the time of the transaction – and the timestamp reported by both entities must be within an hour of each other.
Further, it’s not uncommon for a variety of lifecycle events to occur throughout the course of the trade, meaning updates must be observed closely across as many as 153 data fields – with as many as 80 of those fields required to be matched. For John Kernan, senior vice president, head of product management and business development at European trade repository REGIS-TR, life is about to get much more complicated.
“We expect under SFTR there are going to be many more lifecycle events that will have to be reported than we’ve seen under Emir,” he says. “You lodge your initial trade report, then there could be any number of events that require you to update that event through lifecycle reporting. That could be things like you use automated collateral optimisation. There are various intraday loan products – like intraday trades opening and closing. So we can expect many multiples of the number of messages that we receive from market participants, certainly compared to Emir.”
For FIS Global’s Lewis, that could amount to a vast number of problems.
“We look at clients of ours who easily break a million lifecycle events per day and that’s one client. We have 170 odd installations in our systems around the world and they have multiple entities,” he says. “If you look at a situation where we go back to the pairing and matching: if 10% of those lifecycle events had one issue – one break in them – that’s 10,000 breaks per day per client. So the complexity and the volume is huge and it’s going to take a long time for the process to settle in and, indeed, for Esma to get their heads around what they are going to have.”
Because of the fact that Europe’s SFTR must be reported in transaction plus one, the global securities financing market could come under strain, says Kernan. “For market participants the timing of SFTR is going to be challenging to get the reports in T+1. They might be using a global custodian as their lending agent, or as a triparty collateral manager,” he says. “That custodian may well be located in the States. To try to get all that information, reconcile it, consolidate it, get it in ISO20022 format and over to the trade repository on time – that’s going to be challenging.”
Lessons from the past
SFTR has been some time in the making. The regulatory technical standards outlining the rules were published in March 2017 by Esma, and then due for ratification by the European Commission, but there was little reaction from the latter until July this year. In the meantime, Esma has provided a number of iterations of its Q&As in order to clarify the original technical specifications, in the hope of avoiding issues that arose with Emir. While updates are expected in the coming weeks – and few changes expected – its left market participants in limbo: having to build complicated systems and provisions around a set of rules that may be adjusted potentially just months before the go-live date.
Market participants seem keen to get their houses in order; Kernan reports that REGIS-TR has identified a huge degree of readiness – especially among tier one players, many of whom have supplied “in some instances more than 300 questions” on the trade repository’s SFTR offerings.
Further, market participants are not coming to SFTR as unprepared as they were for Emir. For instance, this time round, legal entity identifiers (LEIs) are much more commonly used by firms everywhere. But the delay has been a frustrating one, says Lewis, and questions surrounding LEIs still need to be resolved – especially as SFTR was originally due to go live shortly after Mifid.
“The momentum that we have is strong – the market has done very well in getting its ducks in a row. I’m a little bit concerned that the longer this hiatus goes on with the Commission and Esma fighting over jurisdiction of who has what over LEIs etc, as well as the delay in getting the technical standards ratified by the Commission,” he says.
“The longer that goes on the greater the risk to the momentum that we have, so if you think about it from a bank’s point of view they are expecting to be much further along this curve by now so they have projects, people and budgets in place – some of which are now sitting twiddling their thumbs and saying ‘there’s nothing else we can actually do at the moment until this thing happens’. There is a risk that expertise or resource will be disbanded onto different projects and someone going ‘well it’s not going to be live until Q1 2020 so let’s go and do something more interesting’.”
Others, however, have welcomed the delay, and the fact it’s given market participants time to adjust to what’s ahead, says Andrew Dyson, CEO of the International Securities Lending Institution (Isla).
“These delays have probably allowed the market to properly digest Mifid, because if you are a large bank you don’t have endless people waiting around to do this work – do you therefore keep putting your Mifid reporting teams onto SFTR now? The sequencing has probably worked out OK in some ways because it means that banks haven’t had to double up on resources. Also it’s allowed the market to think about it a little bit more in terms of how they want to approach the reporting obligations and think about whether they are going to work with partners and vendors etc.”
Given the volume of data required, and the weight of responsibility placed upon each entity on both sides of the trade, industry bodies such as Isla and the International Capital Market Association (Icma) have brought together as many market participants as possible to engender a deeper and wider agreement of the interpretation of the rules.
But even with the delays, a good level of understanding of the rules, industry bodies pulling members together and lessons learned from the past, a rush to get ready is still expected – similar to that which preceded Mifid II late last year.
“That will almost certainly happen, because with the best level of project planning and the best resources you cannot predict every nuance,” says Kernan. “So that will happen. At the same time I’m optimistic because of the prevalence of the trade matching and reconciliation upstream to the TR.”
Isla’s Dyson, however, says there could be a rush just before the regulations go live. “Large banks tend to focus on things when they are more immediate than longer term but that’s the nature of investment banks,” he says.
Questions on the data
With the huge swathes of data headed Esma’s way, questions have been raised by a number of market participants over how the regulator will actually be able to make sense of it, or what they’ll do with it practically.
Perhaps more pertinent to European securities and banking market participants, however, is the question of what will come next. The finalisation of the prudential capital rules around Basel III are expected, as well as the standard three to five year review of the rules put in place by Esma. But the industry is split on whether similar regimes could be in the offing. FIS's Lewis believes SFTR could be a platform upon which further regulations are built.
“They have asked for an awful lot of information and there’s a couple of schools of thought on this – my perception is that more regulation is bound to follow,” he says. “There’s no other reason I can think of that they would ask for the kind granularity of data in terms of fees and rates, for example, that won’t lead them to make assumptions on the market or take a view on the way the market is working, and bring forward new legislation in due course.”