When the SFT counterparty is a UCITS or AIF, the reporting obligation applies to the management company or AIFM as opposed to the fund itself.

What is an SFT?

Broadly speaking, an SFT is any transaction by which a market participant uses securities to borrow cash, or vice versa.

An SFT gives the market participant the opportunity to access secured funding through the temporary exchange of its collateralised assets as a guarantee. Lending or borrowing securities and commodities, repurchase (repo) or reverse repurchase transactions (reverse repo) and buy-sell back or sell-buy back transactions, including collateral and liquidity swaps, are some typical examples of SFTs.

In each of the cases above, ownership of the securities temporarily changes in return for cash.

At the end of an SFT, the ownership of the securities reverts to the original owner, leaving both counterparties in their original positions, plus or minus a small fee (depending on the purpose of the transaction).

In this respect, SFTs act in a way similar to collateralised loans.

SFTR overview

The SFTR introduces, among other things:

• a transaction reporting obligation in respect of securities financing transactions;
• an obligation to make prescribed pre-contractual disclosures to UCITS and AIF investors in respect of SFTs and total return swaps in every UCITS/AIF prospectus and annual return; and
• provisions for "minimum transparency requirements" relating to the “re-use” of collateral (financial instruments only) under financial collateral agreements.

SFTR reporting obligation

The SFTR requires both financial and non-financial market participants to report details of their SFTs to an approved EU Trade Repository or TR. This is in addition to any requirement to report transactions that might arise from the European Market Infrastructure Regulation (EMIR) or Markets in Financial Instruments Directive/Regulation (MiFID/MiFIR) and is part of a general move to increase transparency in the capital markets.

In order to align reporting standards to the maximum extent possible, the European Securities and Markets Authority (ESMA) has developed its reporting standards for SFTs building on its experience with EMIR and other EU-wide reporting regimes.

Transactions that must be reported in accordance with the SFTR include:

• repurchase transactions
• securities or commodities lending and borrowing;
• buy-sell back and sell-buy back transactions;
• margin lending transactions;
• collateral swaps;
• liquidity swaps;
• modifications;
• collateral updates and valuations;
• margin valuations for CCP-cleared transactions;
• collateral reuse and margin lending funding sources; and
• transaction terminations and positions for CCP-cleared SFTs, if the reporting party in question is opting to report modifications and collateral updates as positions.

Broadly speaking, the SFTR applies to all EU financial and non-financial counterparties, including all branches irrespective of their locations and the branches of non-EU entities that are situated in the EU.

Commencement of SFTR reporting obligation: dates for your diary

• 13th April 2020 – investment firms and credit institutions must report.
• 13th July 2020 – CCPs and CSDs must report.
• 12th October 2020 – other financial counterparties (this includes insurance/reinsurance undertakings, UCITS and AIFMs) must report.
• 11th January 2021 – non-financial counterparties must report.

The main problems

The SFTR poses another significant hurdle for firms engaged in SFTs. The main obstacles are as follows.

• Data gathering/population. There are 155 reportable fields, although the XML currently has 170-180 fields depending on the type of SFT and the XML structure is complex. Firms need to ensure for reporting purposes that they have filled in all the necessary fields correctly. If one single validation rule fails, then the entire report fails. In addition, the LEI of the issuer is mandatory for firms inside the EU, or when there is an EU security.
• Timeframe. Coupled with the above, the timeframe of T+1 (i.e. sending off a report within a day of the order being executed) is an incredibly short one in which to obtain all the data that one must use to make a valid report. The validation rules are strict and have proven hard to meet. This is then compounded by the fact that as noted above, if a single validation rule fails, then the whole report fails, and the firm is likely to breach the T+1 requirement.
• Reconciliation. This will occur to the data submitted by both counterparties to the SFT which is held by/sent to the relevant TR. In most cases, a trade will be paired with the other side of the trade and then reconciled/matched against the other fields. Also, reconciliation might happen between the internal records of a firm, with the TR holding records after reporting to make sure that reporting occurred correctly. Although the regulations do not explicitly require reporting parties to reconcile data, they do oblige them to ensure that accurate and complete reports are made, which implies that the data must be reconciled somewhere and somehow. The main point to glean here is that the only places that will have access to all the data needed for correct reconciliation will be the trade repositories.

What should affected firms do?

Every firm should try to select a TR or a third-party agent that best suits its reporting needs in terms of cost and operational efficiency. It must also analyse the things that the SFTR requires it to do and produce an action plan for compliance, keeping its business and/or operations in mind. In terms of reporting, it should also produce sample reports in line with the nature of the transactions that it carries out. Once it understands the requirements fully and drafts its report templates, it ought to develop systems to automate the generation of reports while ensuring consistency and accuracy. This process requires careful organisation and co-ordination between the dealers, the compliance department and the IT people.

A costly business

It is going to be a costly exercise to comply with the regulatory demands of the SFTR, both in terms of labour and capital. Firms have to plan carefully and avail themselves of  as much regulatory expertise to meet the challenge of analysing the applicable requirements of the SFTR and of developing the technical means and infrastructure to cope with them. Furthermore, every firm that has to report to TRs will have to pay some out-of-pocket costs. The reporting and reconciliation process might also take up a substantial amount of time if it is not automated.

Furthermore, firms should consider their internal resources and perhaps hire additional resources or use the services of experienced external consultants on various tasks. A suitable compliance advisor should be able to bridge the gap between law and practice, spot the answers to sundry problems and help the firm in question deal with shortages in resources.

Financial services firms are largely driven and affected by developments in the regulatory landscape, with SFTR being the latest addition to the heightened scrutiny being placed on firms. There is very little time left for firms to make themselves compliant with the SFTR and they ought, therefore, to root out all remaining problems in the short time left to them.

* Graham Levi-Samper can be reached on +44 (0)20 7399 4980 at graham.levi-samper@complyport.co.uk