This article was first published on Lexis®PSL Banking & Finance on 22 December 2014.
EU Council agrees transparency rules on securities financing transactions, LNB News 20/11/2014 80.
A draft EU Regulation aimed at improving the transparency of securities lending and repurchase transactions aims to enhance financial stability and to prevent financial intermediaries, including banks, from attempting to circumvent regulation by shifting parts of their activities to the shadow banking sector. The Council of the European Union has agreed to begin negotiations as soon as the negotiating team of the European Parliament is entrusted with a mandate.
What types of arrangement are caught by the draft Regulation?
The draft Regulation covers two types of activity:
- SFTs - for which the draft Regulation aims to improve transparency by way of reporting and disclosure
- re-use under collateral arrangements - for which the draft Regulation aims to improve transparency by way of disclosure, and introduces requirements for the express knowledge and consent of the collateral provider
The scope of the draft Regulation therefore differs for each.
The draft Regulation covers:
- securities lending
- commodities lending, and
- margin lending arrangements
Previously, the draft Regulation prepared by the Commission also referred to transactions which have equivalent economic effect, such as total return swaps, liquidity swaps and collateral swaps—although references to these do not appear in the Council's draft text. It remains to be seen whether such additional types of transaction will be covered in the final text or whether a middle ground will be adopted, such as the Council's earlier proposal of allowing the Commission to add to the list of SFTs after consultation with the European Securities and Markets Authority (ESMA).
The draft Regulation applies to the re-use of financial instruments received as collateral under a financial collateral arrangement, either by receiving that collateral under a title transfer arrangement or by exercising a right of use in a security interest financial collateral arrangement.
What are the current transparency and reporting requirements and how will these change?
The draft Regulations reflect a significant change in the transparency and reporting requirements applicable to SFTs and re-use, as it is the first time that requirements of this type have been introduced for those arrangements at an EU-wide level (save for reporting requirements under the European Market Infrastructure Regulation (EU) 648/2012 (EMIR) in relation to derivative transactions within the scope of EMIR).
Broadly speaking, the new requirements are as follows:
In the case of SFTs, the draft Regulations require counterparties to report their positions to trade repositories--similar to the type of arrangements applicable to over-the-counter (OTC) derivatives under EMIR. The draft Regulations also require managers of undertakings for collective investment in transferable securities (UCITS), UCITS investment companies and alternative investment funds (AIFs) to disclose information relating to SFTs in their annual reports and prospectus.
In the case of re-use, in addition to requiring the managers of UCITS, UCITS investment companies and AIFs to disclose information relating to re-use in their annual reports and prospectus, the draft Regulations prohibit re-use of financial instruments received as collateral unless certain requirements have been satisfied--most notably that the collateral provider has been informed in writing of the risks and consequences of giving its consent to re-use and (having been so informed) has granted its express prior consent. Note that this prohibition applies not just to managers of UCITS, UCITS investment companies and AIFs, but applies equally to other counterparties who are within the scope of the draft Regulations.
How will this regulation enhance financial stability?
Much like the reporting regime under EMIR, one of the principal aims behind the draft Regulations is to enhance financial stability by increasing transparency. This is considered to be particularly important in the case of SFTs, given the parallel European proposals prohibiting certain types of trading activity from being carried out by banks (the draft Regulations on structural measures improving the resilience of EU credit institutions) and the concerns around such activities as a result becoming more concentrated in the so-called shadow-banking sector. What remains to be seen is how making information available to trade repositories and regulators will improve financial stability. What will be important is what the regulators do with the information--although it is perhaps easier to see a more direct effect on market awareness in the case of disclosure by managers of UCITS, UCITS investment companies and AIFs in their annual reports and prospectus.
In the case of re-use, the draft Regulations seek to enhance financial stability by ensuring counterparties who have provided collateral are aware of, and have consented to, the risks associated with that collateral being reused by the collateral taker.
What will practitioners need to think about in light of the draft regulation?
Once the draft Regulation has been finalised and technical standards have been prepared, the market will be in a better position to consider the precise impact of the proposed changes. The effects of the draft Regulation will likely be felt most strongly by those involved in the operational aspects of reporting, since counterparties will need to ensure they have the systems and infrastructure in place to facilitate reporting. From a legal perspective, the same issues as were faced with reporting of OTC derivatives under EMIR are likely to require consideration--including whether suitable arrangements can be put in place for the delegation of the reporting function by one party to another (either its counterparty or a third party service provider)--if such delegation is to be permitted. Parties to financial collateral arrangements (in particular, security interest arrangements) will also need to consider how best to achieve informed consent to any right to reuse financial instruments received as collateral.