In asking market players to shed more light on their securities finance transactions, European regulators have unintentionally opened an operational and legal can of worms.
The newly passed European Securities Financing Transactions (SFT) legislation includes a requirement that managers of new European traditional and alternative investment funds disclose their policies involving securities finance transactions in their offering documents. However, it is the mandate for data reporting that worries firms the most. With the nitty-gritty technical specifications — the messaging format, identification requirements, workflow process and standards for accrediting trade repositories — still not released by the pan-European securities watchdog European Securities and Markets Authority (ESMA), securities finance operations, technology and compliance specialists are in a lurch. They don’t have much time to prepare for the data collection and transmission tasks just around the corner. Nor do trade repositories, which must accept and validate data received from market players to publish in some aggregate form.
As of January 2018, fund managers, their custodian banks, broker-dealers and prime brokers will deliver data on securities lending deals, repurchase agreements, buy/sell-back transactions and margin lending to accredited trade repositories. Managers of European traditional investment funds and alternative investment funds will be legally responsible for reporting. Financial firms domiciled or with offices in the European Union as well as those executing securities finance deals in the European Union will also be affected. So might any firm reusing collateral outside Europe.
Topping the list of potential trade repositories are commercial data providers such as FIS and Markit, electronic securities lending platforms such as EquiLend. International securities depositories Euroclear and Clearstream as well as the London Stock Exchange Group’s trade repository Unavista are also expected to compete for the task. The data, which will be stored for five years, includes the economic terms of each deal, the collateral type and quality used, whether the collateral is available for reuse, the repurchase rate, lending fee, margin lending rate, haircuts, value date and maturity date.
Do They Want the Job?
“We do have trade repository-like services,” acknowledges Jamie MacDonald, general manager of FIS Securities Finance, a unit of financial technology giant FIS, who won’t confirm whether or not FIS wants to be an official trade repository for securities finance deals. The designation carries substantial work. Trade repositories must send the data to local regulators to pass along to the Financial Stability Board (FSB), the Basel, Switzerland-based international body that makes recommendations for the global financial system. Because trade repositories will submit aggregate data, the job may be far more work than simple data collection. They might be forced to do data reconciliation and validation, which means they face legal liability for errors.
Why does the FSB want this information? It is looking increase transparency in “shadow banking” in which financial firms are transferring risks off their balance sheets. Securities lending and repurchase agreements fit into this category. The FSB broached the issue of data collection for securities finance deals back in 2012 and in 2013 put forward a more intricate plan with trade repositories serving as data collectors. The idea of delivering real-time streaming data was scrapped in favor of next-day data.
Securities lending agreements are trades in which one party temporarily hands over securities to another — a borrower — in exchange for cash or other assets as collateral. To boost their investment returns, Fund management firms typically act as lenders using custodian banks as their lending agents or middleman. Those agents will earn a percentage of the fees earned by the fund management shops. Repurchase agreements, variations of securities lending deals, call for the sale and later repurchase of a security at a higher price. Custodian banks often operate as administrative middlemen in triparty repurchase deals. Euroclear and Clearstream are considered the largest triparty repo agents in the European market.
The FSB thinks it can crack down on systemic risk in the securities finance market by asking the counterparties involved to cough up information, but with so many players involved in handling each transaction, not to mention the multiple trade repositories, it may not be that easy to boil it down to non-duplicative data and consistent reporting standards. “The securities finance market has not defined whether the lender, the lending agent or the borrower would be responsible for the transaction reporting,” explains John Arnesen, global head of agency securities lending for custodian bank BNP Paribas Securities Services in London. Without a consensus, there is a good chance that multiple parties could be emailing the exact same information or even worse variations of the information on the same trade. Hence trade repositories might be faced with sorting out double-counted trades.
Where’s the Data?
Finding the information is harder than it sounds. Commercial data providers, such as FIS and Markit, do have some basic information on securities finance ideals from their customers, but they might not have the fees paid by borrowers, the amount and type of collateral used and whether cash collateral was reinvested or not. That is where fund managers, broker-dealers and custodian banks come into the equation, but also where sourcing the data could become really complicated.
Information on plain vanilla securities lending deals might be on one operating system, repurchase agreements on another, and collateral information on yet another. Even if the data can be located quickly, it is not static. Unlike executed equity trades, securities finance trades have a “lifecycle.” There may be change in lending rate, substitution in collateral, extension or cancellation of the deal, or the security could be recalled. Potentially, the information for each transaction would need to be updated and verified daily, because stale data could be wrong data.
Operations managers at several European fund management firms contacted by FinOps Report say they expect to be the ones to report the trades, but they don’t know if broker-dealers are willing to leave reporting in their hands alone. And even if they did, just how would the transaction be identified for a trade repository’s reporting to a local regulator?
The same operations managers tell FinOps that they expect the underlying fund lenders to be identified using legal entity identifiers (LEIs) obtained from national numbering agencies or other designated issuers of LEIs. What is still up in the air is what will be used as a unique trade identifier for each securities finance transaction. Without such a code, it could be easy to lose track of a deal during its lifecycle. So far, there seems to be no clear strategy, and another tussle similar to the current debate over how to identify over-the-counter transactions for the purpose of regulatory reporting may be brewing.
Outsourcing an Answer?
Concerned about their ability to handle the reporting workload, fund managers could turn to their lending agent for help. Custodian banks might have the data and be willing to do the work, says Arnesen. However, as is the case with all outsourced work, the devil is in the details. “Custodial agreements will need to include just who will be responsible for tracking the data and who will be responsible for transmitting it and where it will go,” cautions Arnesen. “Once the operational process is ironed out, legal liability must be ironed out.”
What about cost? Arnesen doesn’t think custodian banks will be hit with any exorbitant additional expenses, so they might be willing to absorb the cost as the price of doing business. Naturally, that spirit of generosity could be put to the test if custodians determine that the cost of data collection and reporting is more than just incremental. They could eventually be forced to pass along the expense to fund managers who would have to decide how it would be allocated to underlying fund customers.
Given that complying with the new securities finance data legislation will require substantial work and cost, is the result worth the grief? Maybe not. “It is unclear whether ESMA will have the means to analyze the data from multiple data formats,” says MacDonald. “It is also uncertain as to whether double counting can actually be eliminated unless trade repositories could do so by matching up the UTIs or only one party to the transaction does the reporting.”
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