Heiko Stuber, Senior Product Manager at SIX, discusses what SFTR - perhaps the most complex rule the industry has faced since the 2008 crash - will mean for market participants in the short- and long-term, and how they can best prepare.
Waiting ages for a major regulation to come along, and as soon as it arrives another new rule quickly follows. Before the industry has a chance to fully iron out all the post-MiFID II wrinkles, another regulation comes along. This time, compliance eyes are gazing upon the traditionally underreported world of repos, securities lending, and the re-use of collateral.
Coming partially into force in April 2020, the Securities Financing Transactions Regulation (SFTR) is set to become perhaps the most complex rule the industry has faced since the 2008 crash. From margin-lending transactions on a daily basis, to numerous collateral updates and valuations, market participants spanning right across the industry, even commodity trading businesses, face a monumental task when it comes to reporting. As a case in point, prime brokers will have to report specific information surrounding their margin lending to hedge funds, including intricate details such as what percentage of assets in their portfolio is being used as collateral. The trouble is that, unlike the more straightforward collateral classification rules under MiFID II, SFTR forces a much more in-depth assessment of the quality of collateral.
When it comes to classifying the quality of collateral required, firms need to take information supplied by credit rating agencies such as a Moody’s or Standard & Poor. The problem is that an official data license is needed to do this – which is incredibly expensive to obtain. This is why ESMA is busily seeking out alternatives beyond relying only on ratings supplied to the market. But with six-months to go before the first stage of SFTR kicks-in, can the market really afford to wait for further regulatory guidance before working out how they plan to get their collateral reporting houses in order?
The answer, given the sheer volume of different fields (between 145 and 150), which include counterparty, loan, collateral and margin data, is clearly no. Some data fields are, of course, more complicated than others. There are a couple of reference data fields, for example, that are particularly challenging. Obtaining the Legal Entity Identifier (LEI) is a prime case in point. As an EU driven regulation, what happens if in the event of a no-deal Brexit, securities issued by UK issuer serving as a collateral buffer but, there is no obligation to provide an LEI? If the issuer is based outside the LEI could go missing as there would be no legal obligation to provide it. Getting hold of this insight requires shifting through a huge amount of complex data just to work out who the owner is of the information.
The only place for firms to start is to begin the processes of making sense of the plethora of different data fields. It is not just a case of understanding the data itself, but working out where the data is coming from. Is it coming directly from trading venues or through bi-lateral agreements? Also, how exactly is the information going to be reported and how does a trading firm make sure it gets the correct counterparty details?
For too long now, the industry has been crying out for a way to address the longstanding reporting shortcoming in the securities market. It may have taken time to emerge, but SFTR is the crucial missing piece in this complex regulatory jigsaw market participants have been piecing together over the past decade. The good news for firms is that, thanks to MiFID II and EMIR preparations, much of the reporting groundwork is already in place for SFTR. With so much importance on data quality, the starting point has to be ensuring that they are able to identify, access and work with the real data that they will need. Those that can find a way to measure and provide fully visibility into exactly what has been reported first, will be best placed to tackle other regulatory challenges. After all, with major changes to the structure of repo trading not to mention the significant collateral management issues to consider, reporting is by no means the only thing the market has to address when it comes to SFTR.
Heiko Stuber is Senior Product Manager at SIX