1. Home /
  2. About us /
  3. KAS Insights /
  4. SFTR reduces systemic risk and...

SFTR reduces systemic risk and increases transparency

The 2008 global financial crisis revealed regulatory gaps, ineffective supervision, opaque markets and overly-complex products in the financial system. Since then, the European Union adopted a range of measures in order to render the banking system more solid and more stable, including strengthened capital requirements, rules on improved governance and supervision, and resolution regimes.

One of these regulations is the Securities Financing Transactions Regulation (SFTR). The SFTR is currently estimated to go live in Q2 2019. What have been the recent developments on SFTR and what is its impact on the financial industry and your organisation?

07 Aug 2018

Share on  

What are SFTs?

SFTs, other equivalent financing structures and re-hypothecation play a vital role in the global financial system. SFTs consist of any transaction that uses assets belonging to the counterparty to generate financing means. In other words, SFTs are transactions where securities are used to borrow cash or other securities. SFTs act like collateralised loans. In practice, this mostly includes lending or borrowing of securities and commodities, repurchase agreements (repos) or reverse repurchase transactions, or buy-sell back or sell-buy back transaction, Margin finance and Collateral, and liquidity swaps. 

Eliminate dark corners and monitor shadow banking

During the financial crisis, regulators and supervisors found it difficult to anticipate on risks in securities financing. This was mainly due to lack of data. It was reaffirmed on several occasions by the G20 that the overarching aim of SFTR is to eliminate the dark corners in the financial sector that have a potential impact on systemic risk, and to eliminate areas that are a result from regulatory arbitrage. SFTR aims to counter this by extending regulation and oversight to all systemically important financial institutions, instruments and markets.

The crisis of 2008 highlighted the need to improve transparency, and to not only monitor the traditional banking sector but also monitor areas where non-bank credit activities took place, called “shadow banking”. Shadow banking is described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. Ultimately, the scope of the proposed regulation is very broad.

Transaction reporting under SFTR is similar to EMIR reporting

In January 2014, The European Commission (EC) published the SFTR, following recommendations by the Financial Stability Board (FSB), and European Systemic Risk Board (ESRB) to regulate reporting on SFTs and increase transparency, and to implement better regulation on shadow banking. Companies are required to report their SFTs to an EU-approved central database, also known as a trade repository. Additionally, overarching companies of UCITS and AIFs must provide periodic reports to investors when they operate SFTs and similar financial constructions.

SFTR transaction reporting is structurally identical to EMIR reporting in that it requires two-sided T+1 reporting, there are similar counterparty classifications and requirement by counterparties to send one report containing the complete data set to ESMA (European Securities and Markets Authority). On a side note: KAS BANK already delivers EMIR reporting to several clients that comply to EU regulation.

Which companies will be affected?

The EU adopted the SFTR regulation to increase transparency of SFTs by requiring all SFTs, except those concluded with central banks, to be reported to the trade repositories. Information on the use of SFTs by investment funds need to be disclosed to investors in the regular reports and pre-investment documents issued by the funds, in order to comply to the new regulation. When collateral is reused, companies must disclose its risks.

The SFTR will therefore affect a wide variety of companies, including banks, investment managers, CCPs, CSDs, insurance, reinsurance undertakings, pension funds, UCITs, AIFs, and non-financial counterparties.

Increasing the transparency of SFTs

The proposal also explicitly identifies UCITS funds and AIFs as being subject to the regulation in its final form. When the SFT counterparty is a UCITS fund or an AIF, the reporting obligation applies to its management company instead of the fund itself. 

UCITS

The Undertakings for the Collective Investment of Transferable Securities (UCITS) is a regulatory framework of the European Commission that creates a harmonized regime throughout Europe for the management and sale of mutual funds. UCITS funds can be registered in Europe and sold to investors worldwide using unified regulatory and investor protection requirements. UCITS fund providers who meet the standards are exempt from national regulation in individual European countries.

AIF

An alternative investment fund (AIF) is an investment company or an investment fund. It offers opportunities to take part in a fund for collective investment, in order to have the unit-holders share in the proceeds of the investments. Current European law distinguishes two types of collective investment vehicles: UCITS and collective investment institutions that do not qualify as UCITS (alternative investment funds). The UCITS Directive regulates (managers of one or more) UCITS. The AIFM Directive regulates managers of one or more AFIs. In the Netherlands, the authorising authority for both types of investment vehicles is the “Authoriteit Financiële Markten” (AFM). DNB advises the AFM as to whether an investment vehicle meets the prudential requirements of the Financial Supervision Act (the Wet op het Financieel Toezicht, or Wft, in Dutch).

Expected industry challenges of implementing SFTR

When SFTR is in effect, companies are required to declare SFTs to an EU trade repository. Information on SFTs has to be stored for at least 5 years after their completion, modification and termination, as well as a T+1 timeframe for reporting. Additionally, the regulation also aims to launch minimum standards for collateral valuation and intends to eliminate the SFTs possibility of disguising potential weaknesses in financial institutions’ balance sheets.

The jury is still out on the actual success of EMIR, but looking at its developments and impact in the financial market it seems that EMIR has made the (financial) world a bit more of a safer place. As SFTR also aims to improve the banking system by making it more solid and stable, an optimistic outlook on the effect of SFTR (once implemented) is in order. It seems that SFTR will take bank like activities better into account, which will probably help the financial system to become yet another bit more solid, and therefore the world a bit safer.

In the upcoming months it is expected that more information will be provided on the regulation leading up to the live date in 2019. We will keep you updated.

SFTR’s industry impact

A concise overview of the requirements for the different regulations:

  EMIR SFTR (proposed) MiFID
No. of fields 129 153 (product and
report dependent)
65
Product scope Derivatives (OTC & ETD) Securities financing transactions All “financial instruments”
(broadly meaning most
derivatives and cash products
and including SFTs not
covered by SFTR)
Reporting type Trade/Position Trade/Position/Collateral/Reuse Transaction
Regulatory objective Systemic Risk Monitoring Systemic Risk Monitoring Market Abuse/Market
Surveillance
Reporting to Trade Repository (TR)
Obligation is met once a
report has been accepted
by a TR, which then reports
to NCAs, ESMA and central
banks
Trade Repository (TR)
Obligation is met once a
report has been accepted
by a TR, which then reports
to NCAs, ESMA and central
banks

National Competent Authority
(NCA) either directly or via
an Authorised Reporting
Mechanism (ARM)

TR/ARM
supervisor
ESMA ESMA National Competent Authority
(eg. AFM/DNB in NL)
Daily valuation
reports
Yes Yes No

Source: Addressing SFTR's Industry Impacts - the vital role of trade repositories (The Field Effect, DTCC)

Henk Brink

More information on SFTR?

Henk Brink

Senior Market Intelligence Specialist
+31 (0)20 557 5327