Bankers fret over part two of EU securities lending rules

What is happening?

As banks and other financial institutions steadily get to grips with the second Markets in Financial Instruments Directive (MiFID II), they must now gear up to implement part two of the Securities Financing Transaction Regulation (SFTR) – the more onerous instalment, according to some bankers.

SFTR has not generated nearly as much publicity as MiFID II and might appear to be a rather obscure piece of regulation inspired by the Financial Stability Board’s efforts to shine a light on the opaque and sometimes arcane world of securities lending.

However, this market, which covers repurchase agreements (repos), securities and commodities lending, is far from small-time. It is estimated to be a $2300bn market and generates $9.2bn in revenues for the industry.

Securities lending is a handy little earner for asset managers, and is becoming even more so as other forms of revenue such as management fees come under pressure. Typically, this might involve ‘renting out’ shares to a hedge fund to short-sell a particular company or so a shareholder activist can gain enough influence over the board of a listed company to initiate change.

Repos, meanwhile, are crucial to the banking sector and its liquidity and involve the sale of securities, usually bonds, with an agreement to buy them back within a specific timeframe and price.  

Why is it happening?

At the behest of the G20, in 2011 the Financial Stability Board set up the workstream on securities lending and repos, and the following year published a policy framework for addressing shadow banking risks in securities lending and repos.

The concern policy-makers have about securities lending markets is that they can enable non-bank entities and even banks to operate on a significant scale in ways that create threats to financial stability. Also, if the same security is loaned on a number of times it can exacerbate leverage and vulnerabilities in maturity transformation.   

The EU has enthusiastically interpreted this framework into a working set of rules and has been much more prescriptive than other jurisdictions.

Part one of SFTR was about establishing key identifiers around transaction lending, declarations and collateral documentation so that counterparties are aware of associated risks.

However, part two involves submitting very detailed daily reports to trade repositories on all aspects of a securities lending transaction. There are a total of 153 fields in these reports, though in practice most transactions will involve completing 100 to 130 fields, which nonetheless requires gathering an enormous of amount of data from disparate locations.  

What do the bankers say?

One piece of good news with SFTR is that it is largely modelled on the European market infrastructure regulation, with which many bankers are familiar, and they have had practice collecting highly granular data thanks to the demands of MiFID II.

Also, the basic framework of part two of SFTR is already written, so its requirements are well known.

However, there are still unresolved issues around the details. This includes the definition of unique trade identifiers and the use of legal entity identifiers for bank branches, both works in progress.

But an unseemly tussle seems to have erupted between the European Securities and Markets Authority (ESMA) and the European Commission over who should have the power to make technical changes and decide temporary fixes.

In July, the commission sent ESMA some 1500 proposed amendments to its regulatory technical standards. Bankers described many of them as sensible clarifications and also reflected the industry’s wishes to see some changes around the regulation of certain routine transactions.

In early September, ESMA promptly rejected the lot, smashing the ball back into the commission’s court. The commission’s return is eagerly awaited. Technically, the commission could get its way, but would probably prefer a negotiated solution.

Meanwhile, banks would like to see these issues resolved quickly so they can start detailed planning and implementation work.

Indeed, part two of SFTR has been dragging on for some time. It now looks like it will not go live until the first quarter of 2020 at the earliest, as it still has to go through the EU’s policy-making processes.

Will it provide the incentives?  

In principle, SFTR is a good idea because it will illuminate often murky securities lending markets. Greater disclosure will also make users more confident and enable supervisors to spot any dangerous concentrations of risk.

However, the costs of compliance will likely drive out smaller and more marginal players and may see some securities lending activity pushed outside the EU.