So finally the European Commission has indicated that they will be approving the Securities Financing Transactions Regulation (SFTR) Level II legislation this week, with SFTR reporting set to go live in Q2 2020. For many, this will be the trigger for the serious work to start.
Over the past nine months at Catalyst’s regular SFTR forums, it has become increasingly clear that there is a big unknown regarding how ‘buy side’ reporting requirements will be fully satisfied. Most buy side lenders – pension funds, insurance companies, collective funds, and sovereign wealth funds – use their custodian’s or third-party agency lending desks as their route to market and are effectively hands-off from the lending executed on their behalf by their agent lenders.
- The agent lenders who have participated in our forums accept that they hold the data and will create and submit the required transaction reports (although there is still a fair amount of work they need to do to be ready to do this).
- But they are also quite clear – and correct – that the ultimate responsibility for SFTR reporting will reside with the asset owner whose assets are being lent. This then begs the question of how the buy side asset owners are going to satisfy this regulatory obligation.
- Many have very limited independent information, data or records on the loans being booked on their behalf – and certainly not the detail to validate SFTR reporting – and are reliant on what they see from their agent lenders.
How is this challenge going to be resolved? Most agent lenders are beginning to think this through and, for example, considering if an SFTR reporting service will be offered – for a fee.
Buy side asset owners also need to work out how they are going to satisfy their SFTR obligations.
- At the very least this will require an extended and revised oversight and governance approach over their agent lenders and the reports submitted on their behalf.
- Considering the complexity of the whole lending and collateral process with numerous counterparties – and the EU qualifying requirements, there may be a need for the asset owners to significantly develop their own record keeping capabilities to keep abreast of all loans booked and all collateral taken on their behalf throughout each loan’s lifecycle.
- Some may see this as required to ensure they can demonstrate sufficient oversight and an assurance that the SFTR reports lodged on their behalf are complete and accurate.
For buy-side lenders, especially the majority who lend through agents, we recommend a number of additional steps, including:
- establishing what your lending agent intends to do on your behalf and what residual responsibilities remain with you;
- understanding the disclosure requirements for fund prospectuses and financial reports;
- also understanding if there may be commercial aspects due to increased regulatory costs that warrant a review of your lending programme and its parameters; and
- determining your retained responsibilities and oversight obligations.
Without doubt, SFTR brings more transparency to the securities lending and financing business. But for some buy side asset owner lenders, SFTR will introduce obligations that may be considered too onerous: could this lead some to withdraw from lending altogether? It would be an irony if the move to greater transparency results in a reduction in supply and liquidity.
Download our whitepaper: SFTR Securities Financing Transaction Regulation: changes and challenges to address now