This article was contributed by Martin Walker, Head of Product Management, Securities Finance and Collateral Management at Broadridge
For months, the European securities finance industry has been pre-occupied with the implementation of the Securities Finance Transaction Regulation (SFTR). Though for some firms the work had largely been completed in time for the April 13, 2020 deadline, for others, things were looking extremely tight. For many the COVID-19 pandemic changed a tight deadline into a potentially unachievable nightmare. The major industry bodies such as ISLA (International Securities Lending Association) and ICMA (International Capital Markets Association) canvassed the European regulator and a delay was granted until July 13, 2020, but what does the delay really mean for securities finance in Europe?
For most firms, it simply means more time to complete testing and raise the quality of the data that will be reported. Nobody is taking the opportunity to simply slow things down and relax. The predominant attitude is simply to get projects completed, in order to end project running costs and to allow more focus on other priorities.
However, it’s worthwhile for everyone involved in SFTR to reflect a little on the lessons learnt from the work done so far and the potential consequences of the regulation. If the regulation had gone live on April 13th, it is very likely the securities finance industry would have found itself in a similar state to the derivatives industry after the go-live of a similar reporting regime for derivatives, i.e. drowning in breaks from trade repositories’ reconciliation for both sides of each trade. Regulators, notably those involved in prudential regulation at central banks, may well have found themselves trying to use every statistical technique possible to get a realistic view of the market after excluding all the data of unusable quality. So, what should people be thinking about between now and July?
Many firms still have considerable work to do on operating models for a post-SFTR world. For many, there are still unanswered questions about how to manage exceptions, rationalize operational processes and how to reach agreements with counterparts about how to book trades when they have different booking models. For example, in the worst-case scenario, trades can be reconciled three times per day, but generating more breaks need to be analyzed and resolved. This would involve pre-reporting reconciliation with counterparties, a “contract compare” reconciliation (part of standard operational processes in securities lending) and reconciliation by trade repositories after trades have been reported. In addition to this valueless duplication, there would be the potential for confusion in responsibilities between operational and regulatory reporting functions.
In addition to the more operational side of their operating models, firms need to think more deeply about their front office booking models and managing client relations to bring about consistent booking of trades with counterparties. Regulators are not going to find it acceptable if one party to a trade books it as a Reverse Repo and the other party as a Stock Loan. The focus of regulatory reporting in the derivatives area has been on macro-prudential regulation i.e. the potential impact of various business models on the overall stability of the financial sector. This time it is quite likely that regulators will also be interested in the conduct side of regulation. Trades related to dividends on equities have been subject to a great deal of scrutiny for over a decade by both regulators and tax authorities. Scrutiny that is not diminishing and in March saw the criminal convictions of two former stock loan traders. Historically, there has been a great variety to the complexity, if not legality. Capital Markets management need to be aware of the level of transparency of SFTR dividend related trades. Three extra months should give firms time to make sure they are both visibly compliant with rules related to dividends.
The other big area that requires considerably more thought before go-live is data. It is very easy so say SFTR will ultimately provide better quality data for firms to make decisions, but how? How long will firms have to wait before data is good enough to trust for decision making? One area of decision making that does not have to wait is post-trade exception analysis. This involves analyzing the exceptions made in reporting (reconciliation breaks, time delays in reporting trades and corrections of errors). This can provide insights into the quality of the reporting process but more importantly the overall quality of firms’ infrastructure, reference data, trade capture process and client relations. The delay also provides additional time to ensure most counterparties and security issuers have LEIs (Legal Entity Identifiers) to agree processes with counterparties to resolve exceptions caused in the generation and exchange of UTIs (Unique Trade Identifiers).
Another key area of data is market data. Market participants across multiple trading areas make a great deal of use of data related to average fees and securities under loan, but could it benefit from a sanity check? Securities lending is an OTC market in most locations, so there is no data from exchanges, there is no guarantee that existing data provides a complete of the overall market for a given stock and it can be challenging to establish what is the “true price” when different forms of collateral are given in return for borrowed stocks. Though there will be a time lag between reporting trades and making the data public, it will provide a very effective tool for improving the existing ways in which market data is used. For the first time, there will be a truly complete picture of the market.
Finally, there is some scope to think beyond the SFTR go-live. Dealing with the on-going challenges of reporting and resolving exceptions will generate more work, even in the best prepared firms. That work will have to be funded. In the current climate the pressure will be on firms to cover the additional costs from squeezing efficiencies gains from other business processes.
Plenty of constructive things to think about over the next three months.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine, Markets Media Group or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community.