On 12 January 2016, the Securities Financing Transactions Regulation (SFTR) entered into force. The SFTR aims to improve transparency in areas where bank-like credit intermediation known as 'shadow banking' takes place and requires financial and non-financial market participants to report details of their securities financing transactions (SFTs). The SFTR also contains requirements on the information in periodical reports and pre-contractual documents of collective investment undertakings. With the publication of its discussion paper on 11 March 2016 the European Securities and Markets Authority's (ESMA) provided guidance on the scope and logistics of the reporting obligations.
Securities Financing Transactions (SFTs) and shadow banking
The European Commission adopted the SFTR as part of its action plan on shadow banking. A wide range of secured transactions will become subject to the reporting requirements imposed by the SFTR. SFTs are secured transactions that have similar economic effects such as 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. The main SFTs covered by SFTR are securities lending transactions and repos.
The definition of an SFT in the SFTR does not include derivative contracts as defined in the European Market Infrastructure Regulation (EMIR).
Shadow banking is considered to be a system of credit intermediation that involves entities and activities outside the regular banking system. Although shadow banks are not regulated like banks, their operations are often similar, as they:
- take in funds similar to deposits;
- lend over long periods and take in deposits that are available immediately (known as maturity and/or liquidity transformation);
- take on the risk of the borrower not being able to repay; and
- use borrowed money, directly or indirectly, to buy other assets.
Shadow banking activities are an important source of finance for financial entities, in particular where securitization, securities lending and repurchase transactions are involved.
The SFTR provides for the reporting of details regarding SFTs entered into by any market participant in the EU and is applicable to both financial and non-financial entities. The purpose is to identify and monitor financial stability risks created by shadow banking activities of regulated and non-regulated entities. Reporting obligations include the composition of the collateral, whether the collateral is available for reuse or has been reused, the substitution of collateral at the end of the day and the haircuts applied. Information on the risks inherent to securities financing markets will be centrally stored and must be easily and directly accessible to the relevant competent authorities such as ESMA, the banks of the European System of Central Banks and the European Central Bank. Transactions with central banks as counterparty are exempted from this reporting obligation.
The obligation to report to trade repositories applies to every counterparty to an SFT established in the EU. This also includes counterparties established outside the EU if the SFT is entered into in the course of the operations of a counterparty's branch located in the EU. The information that is reported should include the details of any SFT as well as any modification or termination thereof and has to be kept on record for at least the following five years.
Transparency in periodical reports and pre-contractual documents
The SFTR also introduces new rules on the transparency of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers (AIFMs). As from 13 January 2017, all UCITS and AIFMs should include detailed information on any use of STFs in their periodical reports and pre-contractual documents to make investors aware of the risks associated with this use.
ESMA Technical Standards
ESMA is mandated to draft Level 2 measures to ensure consistent application of the reporting obligations following from the SFTR. By 13 January 2017, ESMA must have submitted draft regulatory technical standards regarding:
- the details of the reports for the different types of SFTs;
- the registration procedures and application of trade repositories; and
- transparency and availability of data held in a trade repository.
The discussion document published by ESMA on 11 March 2016 sets out ESMA's proposals for implementing the reporting framework and the registration requirements for those trade repositories wanting to accept reports on SFT's. Market participants can provide comments until 22 April 2016.
Although the SFTR entered into force in January, the actual reporting obligations are expected to become effective in the course of 2017. The SFR also includes requirements on, for example, the reuse of collateral and contains rules on contractual arrangements between counterparties that will become effective in July 2016.