New EU rules on securities financing transactions

As part of the EU initiative on shadow banking, the Securities Financing Transactions Regulation (SFTR) aims to improve transparency in the securities financing transactions market. Robert Daniell, senior counsel, William Sykes, partner and Audra Wamsteker, senior solicitor and professional support lawyer at Macfarlanes LLP, outline the key requirements of the SFTR and the obligations imposed on those affected.

What is the SFTR?

The Securities Financing Transactions Regulation (EU) 2015/2365 is an EU regulation that creates transparency for regulators and investors concerning securities financing transactions (SFTs), and requires disclosures of risks associated with providing collateral.

The build-up of leverage in SFTs has been a primary concern of regulators as one form of SFT, ie repurchase transactions (repos), and has been a key constituent in the ‘shadow banking’ system that has grown in size to rival that of the traditional banking system. The SFT reporting requirement in particular is intended to give regulators better understanding of the scope of the SFT market and its users.

Which transactions are affected?

The SFTR affects the following SFTs:

  • repos, including reverse repos and buy-sell backs—repos are a means of securing cash loans with securities as collateral
  • securities lending, which involve shares or bonds being lent against cash collateral
  • commodities lending, which involve commodities being lent against cash
  • margin loans in connection with the purchase, sale, carrying or trading of securities, but excluding any other cash loan secured by securities

The transparency obligations under the SFTR also apply to total return swaps (TRSs).

Reuse of custodied collateral by recipients (often called rehypothecation), and title transfer financial collateral will also require risk disclosures.

Which entities are affected?

The following entities are affected:

  • any EU entity, including its non-EU branches
  • a non-EU entity if the SFT is entered into by an EU branch of that entity
  • undertakings for the collective investment in transferable securities (UCITS) and their management companies
  • alternative investment fund managers (AIFMs) authorised or registered under the Alternative Investment Fund Manager Directive 2011/61/EU (AIFMD), irrespective of where the AIFM’s fund is established
  • for reuse of collateral:
    • any EU collateral receiver (including its non-EU branches) and
    • non-EU entities if the reuse is done by an EU branch or the collateral provider is an EU entity or an EU branch of a non-EU entity

What obligations are imposed?

The SFTR imposes the following obligations:Reporting

Both counterparties must report each SFT to a trade repository within one business day of trading and keep transaction records for five years after termination of the SFT. A non-financial counterparty (NFC) trading with a financial counterparty (FC) is exempted from the reporting obligation if the NFC doesn’t exceed more than two of following:

  • a balance sheet of €20m
  • a net turnover of €40m, and/or
  • an average of 250 employees during the financial year

Further, the parties to an SFT can delegate one party to report for both, and we expect dealers will agree to report for clients, as commonly occurs for derivatives.

Transparency obligation

UCITS funds and AIFMs must disclose their use of SFTs and TRSs in prospectuses and periodic reports to investors. The required disclosures in each document are specified in an annex to the SFTR.

Reuse obligation

For any reuse right on custody collateral and for title transfer collateral, the recipient must obtain from the collateral provider written consent and disclose to the provider the credit and other risks caused by reuse and title transfer. As well as SFTs using financial collateral, passing securities under collateral agreements that rely on transfer of title, such as the English law International Swaps and Derivatives Association (ISDA) Credit Support Annex, are affected.

A number of industry bodies including ISDA and the International Capital Markets Association (ICMA) are working together to publish a standard risk disclosure document to assist users of collateral in this.

Entities must have policies for reporting to regulators any breaches of the reporting and reuse obligations.

What do you need to do?

For those entities that are one of the affected entities listed above, the obligations that currently apply are:

  • record-keeping for SFTs entered into or existing on or after 12 January 2016, and
  • prospectus disclosure for UCITS and funds of AIFMs incorporated on or after 12 January 2016

Obligations that will apply in future are:

  • from 12 July 2016, the reuse obligations
  • from 12 January 2017, periodic reports to investors for UCITS and AIFMs, and
  • from 12 July 2017, prospectus disclosure for UCITS and funds of AIFMs incorporated before 12 January 2016

The reporting obligation implementation is not yet fixed. ESMA must submit draft reporting Regulatory Technical Standards (RTS) by 12 January 2017, and a few months after submission the finalised RTS should come into force (the date of coming into force, the ‘RTS date’). The time reporting then starts:

  • 12 months after the RTS date for investment firms and credit institutions
  • 15 months after the RTS date for CCPs and central securities depositories
  • 18 months after the RTS date for insurance undertakings, AIFMs, UCITS and pension schemes, and
  • 21 months after the RTS date for non-financial counterparties

All SFTs entered into from the relevant reporting start date must be reported by the entity to which the reporting start date applies. As a retrospective reporting obligation, within 190 days of the reporting start date the affected entity must report any SFTs existing at the reporting start date that:

  • had a fixed period of at least 180 days to run, or
  • didn’t have a fixed period left to run but remained open for at least 180 days after the reporting start date

Interviewed by Susan Ghaiwal.

The views of our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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