The time for centrally cleared SFTs is now
By Mike McClain, Managing Director and General Manager of Equity Clearing and DTC Settlement Services at DTCC
Although several upcoming regulatory deadlines are delayed as a result of COVID-19, the pandemic has also highlighted the necessity of many of those very same mandates. This urgency is especially evident around the continued need for greater transparency and risk management across the industry, given that these aims are generally achieved through the adoption of integrated and automated post trade processes that are often spurred by regulatory mandates. While the regulatory delays may provide some welcome temporary relief, it is paramount that regardless of adjusted timelines, market participants continue implementing improvements that will result in a safer and more efficient marketplace.
For instance, in the securities financing space, Europe’s Securities Financing Transactions Regulation (SFTR) is intended to enhance the transparency of securities financing transactions by mandating the reporting of securities financing transactions (SFTs) to a trade repository. While the regulation is expected to introduce benefits for the industry from a transparency and risk management perspective in the mid-to long term, the regulation, like other mandates, creates implementation costs in the short term. SFTR was implemented for the sell side at the beginning of July 2020 and the buy side has been in-scope since 12 October 2020. In order to comply, market participants must implement new trade reporting processes and solutions which will create greater post trade efficiencies.
In parallel, further downstream in the SFT lifecycle – the clearing space – the industry is looking at other areas which could deliver wider efficiencies. The automation and risk management capabilities of a central counterparty (CCP) could create the potential to increase the capacity of the SFT market, reduce counterparty risk, and provide balance sheet relief for participants. The FICC sponsored repo program is an example of the successful application of a similar model to the fixed income market. In this application, the service expanded clearing access to buy-side participants and helped ensure market resiliency by strengthening the overall liquidity of the treasuries market. A similar clearing program for SFTs could port some of these key attributes to securities financing, which would then provide central clearing for equity lending and borrowing transactions.
For market participants, the guaranty provided by a CCP can offer valuable benefits, including mitigating systemic risks by facilitating membership responsibility and cleared transaction opportunities. CCPs may also provide balance sheet and capital relief for the market, as centrally clearing transactions alleviate constraints on would-be members by enabling them to reduce capital usage via netting and improve their risk-based capital ratios. This in turn allows for elevated liquidity levels across the market. Despite some of the operational hurdles posed by participation in an SFT clearing program, many participants who have carried out a cost-benefit analysis find that from a regulatory capital and profitability perspective, there is considerable value in such an offering.
Increasingly the industry is seeking partnerships with third-party vendors and industry organizations, not only to comply with regulations, but also to lower risk, increase efficiency and achieve balance sheet results. Within securities financing, firms should examine their entire processing lifecycle, including in the clearing space, with a view towards ensuring efficiency and improving risk management capabilities throughout the process.