ESMA’s proposals for SFTR and EMIR technical standards

ESMA’s proposals for SFTR and EMIR technical standards

On 30 September 2016, the European Securities and Markets Authority (ESMA) published a consultation paper on draft regulatory technical standards (RTS) and implementing technical standards (ITS) under the Securities Financing Transactions Regulation (SFTR), and amendments to related RTS under the European Market Infrastructures Regulation (EMIR). Pauline Ashall, partner at Linklaters LLP, summarises some of the key points and explains what happens next.

What are ESMA’s proposals for reporting of securities financing transaction (SFTs)?

The most important aspect of the consultation paper (ESMA/2016/1409) is the reporting obligation to be introduced under the SFTR (Regulation (EU) 2015/2365) and the information that will need to be reported. This is particularly important as the SFTR reporting systems will need to be built and tested on a similar timeframe to:

  • changes to the reporting fields under EMIR (Regulation (EU) 648/2012), as set out in ESMA’s final report (ESMA/2015/1645) in November 2015, and
  • the enhanced transaction reporting regime under MiFID II

ESMA proposes to standardise reporting by requiring the use of ISO 20022 and XML. In practice, in cases where one party to a SFT is not a major financial institution (and assuming the transaction does not fall within the single-sided reporting already specified under the SFTR where one party is a financial counterparty and the other is a small or medium-sized enterprise), the less sophisticated party will probably need to delegate the reporting requirement to the counterparty.

Because matters such as changes in the market value of securities lent, and market value of the collateral, are required to be reported (irrespective of whether any further collateral is posted or excess collateral returned), daily reporting throughout the life of a SFT will effectively be required, so the reporting burden is very onerous. Haircuts or margins applied in valuing collateral will need to be included in the disclosure.

What reporting obligations are proposed in the context of margin lending?

As ESMA acknowledges in paragraphs 174 and 180 of the consultation paper, the definition of ‘margin lending transaction’ in the SFTR could potentially catch a broad range of situations that are not economically equivalent to other SFTs. ESMA is seeking more information on the types of transactions that may be caught, but the consultation paper just focuses on margin lending in the prime brokerage context.

In the case of margin lending, reporting needs to cover the lender’s funding sources. The consultation paper discusses (in paragraphs 286 and 287) the difficulties with identifying funding sources for margin lending by prime brokers, and ESMA proposes to require position-level information from the prime broker as to its overall funding sources for its prime brokerage business, rather than at a transaction-specific or individual client level.

What are the proposed reporting requirements for collateral baskets?

The consultation paper notes that article 4(9)(b) of the SFTR enables the RTS to take into account the technical specificities of pools of assets and to provide for the possibility of reporting position-level data for collateral where appropriate. In the case of stock loans and repos, a series of SFTs between two parties is usually collateralised on a net exposure basis, ie a single collateral pool to collateralise all the transactions. Where collateralisation takes place based on net exposures, the consultation paper allows the collateral taker to identify in its report the master agreement pursuant to which the collateral basket has been received to collateralise all the transactions under that agreement, and the International Securities Identification Numbers (ISINs) of the securities comprising the basket.

In the case of prime brokerage, where margin financing is secured on a net exposure basis against the client’s portfolio, ESMA is considering whether it is sufficient to report the whole portfolio as collateral for the margin financing, or to require specific securities or asset classes within the portfolio to be identified as collateralising the amount of the margin loans that are outstanding from time to time. The reporting will be required to disclose, rather than the net amount of margin financing outstanding from time to time, the total margin financing that had been made available and the amount remaining available for borrowing, as well as short market values of the portfolio.

How would re-use of collateral need to be reported?

The reporting fields include whether the collateral is available for re-use and whether it has been re-used. ESMA seems to consider that, in the case of title transfer of collateral, it is not the title transfer itself that constitutes ‘re-use’ but this only makes the collateral available for re-use. The purchase price under a repo will not be treated as cash collateral, but reported under a field for ‘principal amount’. However, if securities are lent against cash collateral, the cash would need to be reported as a collateral amount. This may be problematic, as it could trigger the need to identify and disclose when the cash collateral is ‘re-used’, at least where the lender is a financial institution or corporate that uses the cash collateral in its business, rather than an institutional investor where any management of the cash collateral is carried out by an agent lender acting on its behalf.

Generally, where collateral is managed on a portfolio basis, ESMA accepts that re-use of particular securities comprised in the collateral pool cannot be linked to a particular SFT. In such cases, collateral re-use is to be measured at the collateral-taker level, based on the amount of the collateral pool and the extent to which particular securities in the pool have been ‘re-used’.

What would need to be reported in the case of centrally cleared SFTs?

There is quite a lot of detail in the consultation paper on the operation of the reporting regime where SFTs are cleared through a central counterparty (CCP). In addition to the collateral posted between the counterparties to the SFT, the initial margin and variation margin posted to the CCP will also need to be reported.

How will the proposals impact the registration requirements for trade repositories?

ESMA has issued for consultation a stand-alone RTS on registration of trade repositories (TRs) under the SFTR, and also proposes to amend the existing RTS under EMIR (Commission Delegated Regulation (EU) 150/2013) to ensure that the two are aligned. Broadly, this means some enhancements to the current requirements for TRs under EMIR, in light of weaknesses identified to date.

Are the proposed data requirements for trade repositories consistent with EMIR?

ESMA previously issued a final report in April 2016 (ESMA/2016/422) on amendments to Commission Delegated Regulation (EU) 151/2013 under EMIR, relating to the obligations of a TR to make data available to regulatory authorities, to enable aggregation and comparison of data across TRs, and on the data to be made public. Again, this was to address weaknesses identified to date. ESMA borrows from this in the draft RTS now issued as Annex IX of the consultation paper. The intention is to align the data management under EMIR and SFTR as far as possible.

Is ESMA proposing to clarify the disclosure requirements for funds?

ESMA reiterates that it does not presently intend to issue any RTS to further specify what disclosures are required to be made by UCITS management companies, UCITS investment companies and alternative investment fund managers (AIFMs) under articles 13 and 14 and the Annex of the SFTR with respect to their use of SFTs and total return swaps. However, ESMA will monitor developments in market practice, as well as the quality of data reported by funds, to see whether RTS should be made at some future time.

What happens next?

The consultation paper is open for consultation until 30 November 2016. ESMA expects to submit its final report with draft RTS to the European Commission around the end of Q1 2017. This is later than the timing envisaged in the SFTR, which is for the RTS to be submitted to the Commission by 13 January 2017 (ie one year after the SFTR came into force). Once the RTS have been adopted by the Commission and come into force, they will start to apply on a phased basis thereafter:

  • after 12 months for banks and investment firms
  • after 15 months for CCPs and central securities depositories
  • after 18 months for other financial counterparties, and
  • after 21 months for non-financial counterparties

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

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About the author:
Melanie Ball joined LexisNexis in February 2015 having previously been an associate at Orrick Herrington & Sutcliffe LLP within the Financial Institution Regulatory practice. Melanie was also a member of Orrick’s European Litigation Group. Prior to joining Orrick in 2012, Melanie worked in an advisory role at Morgan Stanley and was a solicitor at DLA Piper UK LLP.