That’s the reaction of fund managers, custodians and market infrastructures to the European Securities and Market Authority’s request for feedback on a new regulation requiring reporting information on securities finance transactions to trade repositories.
Market players complain that ESMA’s technical specifications for complying with the Securities Finance Transaction Regulation (SFTR) would require them to transmit too much unnecessary data too quickly. Asset managers will likely have the lion’s share of operational challenges, because they must distinguish between affected and unaffected underlying investment funds and will have to do reporting for any European fund which comes under the jurisdiction of the Undertakings for Collective Investment in Transferable Securities (UCITS) or the Alternative Investment Fund Managers Directive (AIFMD). Even if a fund manager delegates reporting to a broker-dealer or custodian bank, it will still face legal liability for any errors. The UCITS and AIFMD allow fund managers to easily market their traditional or alternative investment funds respectively if they agree to follow stringent regulatory and investor risk management and disclosure rules.
“If an asset manager does large reverse repos on its cash management desk which it allocates to various portfolios. it will have to divide the portfolios subject to the SFTR from others,” says George Bollenbacher, director of the regulatory compliance practice for consultancy Capital Markets Advisors in New York. “If is counterparty is also a reporting entity it must coordinate the reporting of that portion of the transaction to a trade repository and if its counterparty is not subject to the SFTR it must do the reporting by itself.”
Securities finance transactions are part of the “shadow banking” world or business conducted off-balance sheets that the Financial Stability Board (FSB), the Basel, Switzerland-based international body, wants to monitor. The FSB floated the idea of data collection in 2012 and in 2013 put forward a more intricate plan with trade repositories serving as data collectors. The SFTR was published in December 2015 and the ESMA hopes to draft the final technical rules for approval by the European Commission by January 13, 2017 so that SFTR can be put into action in January 2018. ESMA asked for feedback by April 22, only six weeks after it posed 145 questions on how SFTR should be implemented.
The most common types of securities finance transactions are securities lending deals and repurchase agreements. In securities lending deals, one party temporarily hands over securities to another — a borrower — in exchange for cash or other assets as collateral. Fund management firms typically act as lenders to broker-dealers or prime brokers servicing hedge funds. Repurchase agreements, variations of securities lending deals, call for the sale and later repurchase of a security at a higher price. Custodian banks earn fees to act as administrative middlemen in securities lending and repurchase agreements where they are called agents or triparty agents respectively. International securities depositories Euroclear and Clearstream serve as the largest triparty repo agents in Europe.
Fund managers, their custodian banks, broker-dealers and prime brokers must deliver data on securities lending deals, repurchase agreements, buy/sell-back transactions and margin lending to accredited trade repositories. That information includes the counterparties to the SFT, the principal amount, the currency, the assets used as collateral and their type, quality and value, whether the collateral is available for reuse, any collateral substitution, the repurchase rate, haircuts, value date, maturity date, and details of cash collateral reinvestment. The timetable for the reporting deliverables: no later than one day after the securities finance deal was executed, modified or terminated.
Just who must do the reporting depends on the end counterparty. In most cases double-sided reporting will be the norm under SFTR, as is the case with the European Market Infrastructure Regulation (EMIR) for derivatives which it was modeled after. In the case of any asset managers servicing European asset owners using European broker-dealers as counterparties, both must report the same transaction.
Once the asset manager figures out whether it will do the regulatory reporting or delegate, it must then tackle its reporting requirement to shareholders. Since most funds don’t have a robust technology arm, the responsibility will likely fall on the asset manager. If the fund has more than one asset manager, they would have to coordinate the reporting to shareholders.
Investors who buy funds governed under UCITS and AIFMD must be notified about how SFTs and total return swaps are used in their portfolios in bi-annual and annual reports as well as prospectuses. The information must include the absolute amount of assets engaged in SFTs and total return swaps and the proportion of the fund’s total assets. Because SFTR also aims to improve transparency around the reuse of collateral, fund managers of UCITS and AIFMD- eligible funds must obtain written consent from clients permitting the reuse of collateral.
Although the Alternative Investment Fund Management Association’s response to ESMA’s response for comment might have been among the shortest, it was one of the few to tackle the core issue of double-sided reporting. In doing so, the London-based AIFMA acknowledges that it might be fighting a losing battle because ESMA is not asking for comment about that aspect of SFTR. It could well-be set in stone.
“We note that under EMIR the proportion of Trade Repository (TR) reports being matched in certain products is still extremely low, with the confusion surrounding poor matching rates materially detrimenting regulators’ ability to build an accurate picture of market exposures,” says the London-based AIFMA, which represents alternative fund managers. “The extra layer of cost incurred by buy-side participants required to implement systems to facilitate reporting either on a self-reporting or delegated basis is unnecessary when their sell-side counterparties have all of the relevant information and are in the strongest position to make accurate and useful reports to TRs.” AIFMA’s answer: a singlesided reporting hierarchy to deem the relevant reporting counterparty for a transaction with a tie-break logic should the two counterparties in the same category transact with one another.
Too Much Info
The more data that must be reported to trade repositories the higher the compliance costs, and the greater the chances a report might be rejected. “Authorities should assess which fields are mandatory and which are optional,” says the European Fund and Asset Management Association (EFAMA). “A third level should be recognized for fields that are mandatory but do not constitute blocking criteria if not matched with the counterparty. We should aim at reducing improper rejection of reports that result from the dual sided reporting requirement.”
The Brussels-based EFAMA, the umbrella organization for multiple European investment fund management trade groups, recommends that the ESMA eliminate the place of settlement — securities depository or custodian — where a securities finance deal is settled — because that information is rarely available to the asset management firm. Other fields that should be eliminated relate to classifying the risk of the security used as collateral, the jurisdiction of the issuer of the security used as collateral, the legal entity identifier of the issuer whose securities is used as collateral, as well as detailed information on the master agreement used to execute the securities finance deal. “The ISIN code sufficiently identifies the security. We oppose reference to CRAs [credit rating agencies] and refuse the costs involved,” says EFAMA. Short for International Securities Identification Numbers, the twelve-digit alphanumeric ISINs are assigned to all new issues by national numbering agencies.
The EFAMA also argued that reporting any information on the master agreement governing the securities finance transaction would be far too hard for the front-desk executing the deal to track down. “The front office is not to be burdened with any other complexity than yes or no on the eligibility of a counterparty that relates to the existence of a master agreement in an adequate fashion,” says the trade group.
Rather, EFAMA asked for just the year of the version of the master agreement used, the applicable annexes of the master agreement, and whether the securities finance transaction was concluded under additional terms that modify or complement the master agreement. The Securities Industry and Financial Market Association and International Securities Lending Association (ISLA) have designed master agreements — or standardized legal language — for securities finance transactions.
The timing of the heavy reporting on collateral appeared to trigger the most strenuous push-back from fund management firms and others. “We believe counterparties will often find it difficult to report collateral data within a T+1 timeframe given that the triparty agent may have the discretion to accept or deliver collateral from different ranges of permitted instruments that depend upon the precise instruments may not be known until the settlement date,” says the London-based fund management trade group Investment Association (IA), which suggested a timetable of the day after settlement. So did other respondents.
Offering the most detailed criticism of ESMA’s proposed rules, ISLA recommends when it comes to non-cash collateral, only the ISIN, unit of quotation, quantity, price currency, price per unit, and collateral market value be required. “In our view, the collateral reporting should focus on identifying exactly what collateral has been provided and the market value attributed by each market participant to that collateral,” says the London-based ISLA which represents custodians and buy-side lenders. “Reference data which could be looked up using the ISIN code alone [eg. collateral quality, issuer, jurisdiction of issuer and maturity date] should not be reported by market participants, as higher data quality will be achieved if this information is looked up centrally by the regulators in their own monitoring/reporting systems.” Custodian bank BNY Mellon, which responded individually to the ESMA’s request for comment says that it sides with ISLA.
Haircuts and margins should not be reported because they can be applied in securities lending deals in different ways and the precise methodology may differ by lender, argues ISLA. As for LEIs, because the issuer of a security used as collateral is not a party to the SFT, the reporting party has no clout to ask it to obtain an LEI code, if it doesn’t have one already.
Respondents to ESMA’s request for comments are peeved that not only did ESMA suggest the wrong data content, it also goofed up on the terminology it used to describe some of the participants in a securities finance transaction. Buyers and sellers simply don’t exist the same way they do in derivatives transactions. There are only receivers and deliverers. “In a securities finance transaction either both parties are buyer and seller at different points in the transaction or neither is the buyer or seller,” says IA. “For a repurchase agreement, the counterparty that receives securities and agrees to sell them back at a future date should be identified as the receiver and the other counterparty should be the deliverer. In a securities lending transaction the counterparty that receives the securities should be listed as the receiver and the other counterparty the deliverer.”
When it comes to who should be reporting securities finance transactions, the ISLA says that if the agent lender were to do so on behalf of a fund manager client, the agent lender should report the trade with the LEI of the borrower as its counterparty. The borrower, would in turn, report its trade with the LEI of the agent lender as its counterparty. The agent lender would also have to report the legal assignment of the trade to the beneficial owners. That is because when agent lenders execute and manage loans on behalf of clients, they will typically bulk loan positions together to deliver a single consolidated loan position to a borrower. Upon settlement, the lending agent will disclose the details of the underlying loan to the borrower. Therefore, the agent is the primary source of details on the underlying lending principals.
Although most of the attention about the SFTR is being placed on the specific data content and timing of reporting, the bigger issues of message formats and identifiers has yet to be addressed by ESMA. Market infrastructures and others balked at ESMA requiring financial firms to use ISO 20022-compliant formats as they have not been embraced by all and adoption would be cost-prohibitive. The LSEG, parent of the London Stock Exchange, for one, suggested ESMA add the CSV text format and the XLS spreadsheet format to the mix.
It is unclear how trade repositories will be able to match up the same trade reported by both counterparties separately without a unique trade identifier (UTI). As some of the respondents to ESMA’s request for comments note, ESMA has still not clarified just who would provide the UTI and when that would take place. The London-based Trax, a subsidiary of fixed-income electronic trading platform MarketAxess, offers a possible solution: if ESMA were to require a securities finance deal to be matched on an electronic platform before being submitted to a trade repository, the matching platform could assign the ID. Trax, which provides trade matching and regulatory reporting services, is an approved reporting mechanism for the Markets in Financial Instruments Directive (MiFID).