A rule on collateral re-use within a major upcoming securities financing regulation has become a concern to buy-side firms who believe it may provide a look-through into their underlying trading book.
The Securities Financing Transactions Regulation (SFTR) is due to go live in the second quarter of 2020, and requires firms to report 155 fields on a T+1 or value date +1 basis for their securities lending, repo trades and collateral re-use to trade repository.
Targeting collateral re-use is one of the main pillars of the regulation which has been deemed to give rise to financial stability risks through complex chains. The new rules subsequently require information from the collateral receiver on the risks and consequences that may be involved when granting consent to a right of use of collateral provided under a collateral arrangement.
According to Val Wotton, managing director for product development and strategy, repository and derivatives services and collateral management at the DTCC, for firms opting for delegated reporting, an issue has arisen due to the look-through it would give into the underlying book.
“All firms have to report how their collateral is being re-used, if you want a firm to do delegated reporting on their behalf, do you necessarily want to give them full visibility of how you are re-using your collateral? Because essentially you are giving them full visibility into your trading book,” said Wotton. “A number of funds have raised concerns around how that would work from a delegated reporting perspective. Would you really want to provide that information?”
Reusing collateral has been a way for counterparties to reduce funding costs and also provides liquidity.
SFTR is targeting an area of the capital markets which is less familiar with such stringent regulation, and preparation for the incoming rule has becoming a big topic among firms of all shapes and sizes. While there have been comparisons with derivatives reporting requirements under the European Market Infrastructure Regulation (EMIR), SFTR raises many new challenges for the buy-side.
Wotton added that there is still a lot of education needed for buy-side firms with the phase-in period over 12 months, warning that it is not as simple as waiting for your deadline.
“The interesting thing is around the phase-in is that the large funds are aware that while they’re not necessarily required to go live until October in the third phase – they are actually switched on and the dealers are going to require pieces of information for them from a reporting perspective – whether it’s LEIs, UTIs,” said Wotton.
“For them, they are trying to work out whether they should go with a soft go-live before their actual go-live date because they are going to be asked for information in advance. The question is – depending on the maturity of those funds and asset managers, have they fully understood the impact of the regulation? Do they realise the demands are going to come earlier rather than later?”
The other concern is that firms may be forced out of the securities lending market after the rules are enforced. Banks are worried the resources needed to update operations and ensure compliance will drive out asset managers and beneficial owners from the market.
“We could see liquidity in the market being impacted by SFTR, as some firms may be unwilling to build reporting mechanisms and therefore could leave the market either temporarily or permanently,” said one agent lending bank at a conference in New York, in May. “You need the resources to be complaint, and firms may need to take that from other areas of the firm and implement new technology in order to comply.”
Another head of securities finance, speaking under Chatham House rules, explained that the technology and vendor costs on the agent lender will also make them less profitable, and the rules could take liquidity out of the market.