New EU requirements governing the transparency and reuse of collateral in the form of financial instruments for Swiss entities
Since 12 January 2016 new rules have been in force in the EU governing the repledging and reuse of certain types of collateral. Although these are EU rules, in some situations they may have an extraterritorial impact on Swiss entities that enter into securities financing transactions from a branch domiciled in the EU or repledge financial instruments granted to them by counterparties domiciled in the EU. This means that the rules particularly affect securities lending and borrowing, repo, OTC and trade finance transactions carried out by banks and securities dealers.
1. What Swiss entities are affected?
The regulation on transparency of securities financing transactions (SFTR)1 may impact Swiss entities based in Switzerland as third-country firms in the form of FINMA-regulated and non-FINMA-regulated companies in the following two types of case:
- When entering into securities financing transactions concluded within the context of the activities of a branch in the EU of that counterparty (Art. 2 Para. 1 Section a SFTR). Securities financing transactions are defined as (i) repurchase transactions, (ii) securities or commodities lending, (iii) buy-sell back transactions or sell-buy back transactions and (iv) margin lending transactions. In practical terms this means that securities financing transactions carried out by EU branches of Swiss banks are primarily affected, but also those carried out by Swiss industrial and pharmaceuticals companies.
- In the event of reuse within the context of the activities of a branch in the EU or the reuse of financial instruments2 that a counterparty domiciled in the EU or a branch in the EU has granted the Swiss company under a collateral arrangement, in other words an agreed title transfer financial collateral arrangement (Art. 2 Para 1 Section d SFTR).3 ‘Reuse’ means the use by a receiving party, in its own name and on its own account or on the account of another counterparty, including any natural person, of financial instruments received under a collateral agreement, for example transfer of title or exercise of a right of use. This does not include the mere liquidation of a financial instrument in the event of default of the providing counterparty. In practical terms this means that any Swiss company that is granted and repledges a right of use to a financial instrument by a company domiciled in the EU falls under the SFTR.
2. What transactions by Swiss companies are affected?
The subject of possible obligations on the part of Swiss companies are on the one hand transactions in financial instruments whose reuse is subject to the transparency rules, and on the other securities financing transactions subject to the obligation to report securities financing transactions. Securities financing transactions are:
- Repurchase transactions, i.e. the sale of fungible assets or rights such as securities, goods or guaranteed rights to securities or commodities subject to a commitment to repurchase the same assets or rights or substituted securities or commodities of the same description at a specified price on a future date specified or to be specified.
- Securities or commodities lending or securities or commodities borrowing, meaning the transfer of securities or commodities subject to a commitment to return equivalent securities or commodities at a later date or when requested to do so by the transferor.
- Buy-sell back transactions or sell-buy back transactions, i.e. the sale or purchase of securities, commodities or guaranteed rights relating to title to securities or commodities or such guaranteed rights of the same description subject to the commitment to buy or sell back the same or equivalent securities, commodities, guaranteed securities or commodities at a future date.
- Margin lending transactions, i.e. transactions in which a counterparty extends credit in connection with the purchase, sale, carrying or trading of securities, but not including other loans that are secured by collateral in the form of securities.
With the entry into force of the SFTR the definition of OTC derivatives as per EMIR will be adapted. Now OTC derivatives are defined as derivative contracts the execution of which does not take place on a regulated market within the meaning of Article 4(1)(14) of Directive 2004/39/EG or on a third-country market considered to be equivalent to a regulated market (Art. 2 No. 7 EMIR). Recognition of the equivalence of a third country requires a resolution from the European Commission.
3. What rules apply to Swiss companies that fall under the scope of the SFTR?
Swiss companies that fall under the scope of the SFTR are subject to the following rules:
a. Transparency rules when reusing financial instruments received under a collateral agreement (applies from 13 July 2016 in relation to any collateral existing on this date)
Any right of counterparties to reuse financial instruments received as collateral shall be subject to at least both of the following conditions:
- The providing counterparty has been duly informed in writing by the receiving counterparty of the risks and consequences that may be involved in granting consent to a right of use of collateral provided under a security collateral arrangement or concluding a title transfer collateral arrangement, and the providing counterparty has at least been informed in writing of the risks and consequences that may arise in the event of the default of the receiving counterparty.
- The providing counterparty has granted its prior express consent in writing or in a legally equivalent manner to a security collateral arrangement providing a right of use of collateral or a title transfer collateral agreement.
- Reuse must be undertaken in accordance with the terms specified in the collateral arrangement concluded in writing.
- The financial instruments received under a collateral arrangement are transferred from the account of the providing counterparty, or, if the account of the providing counterparty is held in Switzerland and is subject to Swiss law, are transferred by other appropriate means provided for by Swiss law.
Client accounts should differentiate between securities entered in a securities account and those with a contractual right to the return of equivalent securities (see also Art. 43 Para 2 Section b MiFID for securities firms and banks that hold financial instruments for clients).
b. Reporting obligation and safeguarding in respect of SFTs (valid from 1 January 2017 at the earliest)
Swiss companies as counterparties to securities financing transactions (SFTs) must report the details of any securities financing transactions they have concluded, as well as any modification or termination thereof, to a registered or recognised trade repository. For trade repositories already registered with or recognised under EMIR an application must be made for extension of the registration for the purpose of receiving reports under the SFTR.
The reporting obligation basically applies to both parties. The exception is securities financing transactions with small, non-financial counterparties, where only the financial counterparty has the obligation to report on behalf of both counterparties. In any case, however, the reporting obligation may be delegated to third parties. In the case of funds, the reporting obligation applies to asset managers of collective investment schemes or the fund management company. Reporting as per Art. 4 SFTR constitutes legal justification in terms of the contractual and legal restrictions on disclosure of information imposed by this article. The ESMA will formulate technical regulatory standards governing the details of reports.
For Swiss banks and securities dealers this obligation comes into force on 1 January 2017; for central Swiss counterparties and central securities repositories on 1 April 2017; and for Swiss insurance companies, fund management companies and asset managers of collective investment schemes and funds on 1 July 2017. For non-financial Swiss counterparties, i.e. counterparties not regulated by FINMA, the obligation applies from 1 October 2017.
4. What are the consequences of a failure to comply with these requirements?
Under the national law of EU states (17b recital) a failure to comply with the transparency requirements does not result in the invalidity of the transaction in question. Under Swiss law a failure to comply with the EU rules will also not result in the invalidity of a collateral or transaction arrangement or another arrangement concluded in this connection between a Swiss company and a company domiciled in the EU. However, according to a ruling by the CJEU (Muňoz v Frumar), on violation of directly applicable provisions of the ordinance companies may become liable for damages. EU member states can also impose considerable administrative sanctions.
However, a failure to comply with the reporting obligation explicitly does not result in entitlement to damages. A failure to comply with the reporting obligation affects neither the validity of the securities arrangement nor its enforcement (Art. 20 Para 5 SFTR).
5. What are the next steps?
Swiss companies that fall under the scope of the SFTR should take the following steps:
- Conduct an impact analysis: How and to what extent is my company affected? What organisational areas and processes are affected? What matters of business policy do we have to decide on?
- Identify gaps: What missing documentation, processes and information does my company have to implement? This involves reviewing both existing and new collateral arrangements and processes.
- Draw up a project plan: How does my company go about implementing the missing documentation, processes and information? • Draw up roadmap and milestones: By when must my company implement the missing documentation, processes and information, and what are the main milestones along the way?