This is the second of our posts exploring SFTR with Robert Keane, Product Manager at Pirum. Below, we focus more on the impacts and challenges of this new reporting regime for market participants.
Do the SFTR transaction reporting obligations have different impacts for different types of market participants?
Yes, absolutely. So, for firms on the buyside, Beneficial Owners (owners of the underlying assets) established in the EU who participate in lending, buy-sell backs or repo will have a reporting obligation under SFTR. Where their lending programme is managed by an Agent Lender they may delegate the reporting to the Agent (see Article 4.2), however the responsibility to ensure this is completed remains with the Beneficial Owner.
Agency lending structures typically involve lending multiple Beneficial Owners’ assets in a single transaction, however the reporting requirement will be at the lower, principal level. As borrowers will need this level of information to fulfil their side of the reporting requirement, an increased emphasis will be placed on the accuracy and timeliness of the Agency Lending Disclosure (ALD) data received from Agent Lenders.
Repo dealers and equity borrowers will have to link agency trades to underlying principal level information received via the ALD process, however this may be technically difficult due to the timing and nature of the current ALD process and functionally difficult because of the non-disclosed nature of the information. Any repo and buy-sell back trades executed by EU market participants will also fall into scope.
Prime Brokers will have to report details of their margin lending to hedge fund clients, including details of the portfolio of assets used as collateral (e.g. short sale proceeds).
Moving on to some of the operational challenges about fulfilling these reporting obligations, can you give us a sense of how much data will be involved in this new reporting regime?
Under Article 4 of SFTR, there is a total of 153 reportable fields which is 24 more than EMIR and 88 more than MiFID II transaction reporting. Reports must be made “without exception” in ISO 20022 format to a trade repository (TR). For trades, this must be on a T+1 basis and for collateral, on an S+1 basis if collateral is not known at T+1. Some industry estimates suggest that as much as 40% of these data items are not currently or readily available. Some of the data points included in the current reporting framework are either held in downstream systems or outside of systems entirely. This may require firms to upgrade existing systems and infrastructure to fulfil the reporting obligations.
Whilst the logic of requiring Unique Transaction Identifiers (UTI) for the purposes of matching all parties to a particular trade is sound, it also sounds like a very challenging requirement to implement. Can you comment on that?
Indeed. Agency loans are a great example where these are usually agreed at the bulked level, with the principal information required to correctly generate UTIs only reported via the Agency Lending Disclosure (ALD) process post-settlement date. The European Securities Market Authority (ESMA) have at least published UTI generation waterfall methodology which provides a better framework for understanding at what point UTIs should be generated and by whom.
Earlier this year, ESMA reported good progress on the use of LEIs under MiFID II – can you clarify what the requirements are with respect to the use of LEIs under SFTR and why this could be problematic?
Under SFTR, use of LEIs is mandatory for the following types of entity: counterparties; beneficiaries; brokers; CCPs, clearing members, agent lenders, tri-party collateral providers, CSD participants and issuers of the securities being used as collateral. Whilst we have seen more and more LEIs being implemented within firms’ systems as a result of MiFID II, the use of LEIs is not mandatory in all jurisdictions. From our market research, we already know that the LEI of the issuer will be one of the most problematic fields to source because using Japanese issuers of bonds as an example, they do not have a mandatory requirement to go and get a LEI.
Are there any other impacts or challenges you would like to highlight?
Yes. Whilst the data sourcing, accuracy and lineage are vital to fulfil this obligation, firms should also focus on the need for pre-reporting reconciliations that are complete and accurate to avoid large volumes of breaks post-reporting. This was a big problem in the early days of EMIR, and large volumes of pairing and matching fails can be expensive and time-consuming to fix and can also lead to even more expensive regulatory sanctions.
Do you see any upside for market participants from the SFTR reporting regime?
There are always benefits to be gained from bringing together disparate sources of granular data together in a common format, particularly if this has not been possible before. For example, having a comprehensive and granular data set of all SFT transactions will facilitate better portfolio and collateral management. Depending on the firm and how much work they put into garnering insights from the larger, more transparent data set, other types of analysis will could also be realised such as improved point-of-trade pricing, capital cost calculations and revenue-distribution analysis which can have a direct impact on the bottom line.
We also asked BearingPoint, a leading provider of regulatory data and reporting solutions, for their perspective on SFTR. Luke Jones, a Manager at BearingPoint stated
“the challenges arising from regulatory reporting such as SFTR require not only know- how on functional aspects, but force market participants to focus on scalable software solutions in line with lean processes. Thus, technologies enabling data processing from various source systems and providing a common data model for all reporting regimes that enhance data efficiency, is key to keep reporting capabilities in the long run”
SFTR sounds like a really good opportunity to make use of innovative RegTech to overcome many of the data and control challenges posed by this new reporting requirement.