DTCC's Val Wotton and Oliver Williams explain the challenges SFTR presents in Asia, and how firms can best prepare in the lead-up to implementation starting in April 2020.
Although SFTR (the Securities Financing Transactions Regulation) is an EU regulation, Asian firms will also be affected once the regulation is implemented next year. EU-based ﬁrms, their non-EU-based branches, and non-EU-based ﬁrms executing transactions from an EU-based branch of the firm will be obligated to report their SFTs (securities financing transactions) to an authorised trade repository in a phased manner, starting in April 2020.
DTCC (the Depository Trust & Clearing Corporation) operates one such trade repository. Regulation Asia sat down with DTCC Managing Director Val Wotton and Executive Director Oliver Williams to understand some of the challenges firms will face in the lead-up to implementation, and how they can best prepare.
Regulation Asia: Oliver, in your article earlier this year, you explained some of the impacts SFTR will have on Asian firms. Can you briefly describe SFTR and what it is trying to achieve?
Williams: SFTR is aimed at bringing greater transparency to the securities financing and repo markets. By mandating that SFTs be reported to a central repository in a standardised way, regulators will gain new insights into potential systemic risks. This has been part of the roadmap since 2009 under the post-crisis G20 commitments.
Regulation Asia: Can you recap what kinds of firms SFTR will apply to, and by when?
Williams: SFTR will be implemented in four phases.
In April 2020, investment firms and credit institutions, i.e. banks, will start reporting. Then in July 2020, CSDs (central securities depositories) and CCPs (central counterparties) will start reporting. In October 2020, fund managers will have to start reporting, including hedge funds, pension funds, and insurance firms. Finally, in January 2021, nonfinancial counterparties, i.e. corporates, will start reporting.
Regulation Asia: DTCC published a whitepaper recently detailing the impacts SFTR may have on the industry. What are some of the operational challenges firms will face that we should highlight?
Wotton: What's happened with SFTR is that essentially a derivative regulation has been taken and applied to SFTs. But the SFT market doesn't work the same way.
Derivatives are very much trade driven, and it's a single trade you execute in reality. You may increase or decrease positions, or partially terminate a trade, but it’s not like an SFT, which is more liquid and fluid, and where fundamentally – intraday – you’re changing the position type, and actually changing the allocation of what stock you've essentially lent out on behalf of the beneficial owners.
In the whitepaper, we mention that about 60 percent of all processes will be impacted when it comes to repo and SFT trading. The reality is that firms are having to look at all of their trade capture/booking models.
The SFT market has always worked with end-of-day positions. But in this market, firms are downsizing and upsizing positions over a series of transactions, each of which will have to be reported under SFTR. So, the real question for firms is around how they currently capture/book and represent those ins and outs.
And then – because you have to report all of the collateral movements as well, and you reuse the collateral, and it’s sometimes stored in different systems – you also have to ask how these bits of information are pieced together in order to do the reporting.
Regulation Asia: How much data will have to be reported for each transaction? And what kinds of data gaps do you expect to see?
Wotton: It’s 155 data fields for reporting a securities lending trade, and over 80 reporting fields for repo transactions. Some fields present a bigger challenge than others, of course.
For example, firms are going to have to report ISINs (International Securities Identification Numbers). Where do firms store this information? How do they check the validity of the ISINs they have?
LEIs (Legal Entity Identifiers) will also apply to reporting SFTs so firms must have valid LEIs in place. LEIs have existed for a long time in Europe. While we are starting to see regulators adopting these requirements in the region, a lot of Asia based firms are still not using LEIs.
Another interesting piece is the UTI (Unique Transaction Identifier). SFTR imposes a requirement to pair and match transactions in the trade repository on a T+1 basis.
The only way to match trades is by comparing the UTI and the LEI of the underlying transaction. So, if you want to pair transactions in the repository, you have to exchange UTI pre-reporting. This is something completely new for the repo and SFT markets, which today do not have the concept of a UTI.
Trade associations like ICMA (International Capital Market Association) and ISLA (International Securities Lending Association) are working very hard to determine the process for exchanging UTIs.
Regulation Asia: Given that some of these processes have not yet been worked out, could there be issues around data quality or consistency that would need to be addressed? And if so, how?
Wotton: The challenge for firms is that they all have different trade booking systems which may not capture all the required fields – such as the UTI field. A number of these data points will need enhancement or enrichment from other systems – like collateral systems – to be able to populate all the reportable fields.
There will be an issue of data consistency – it’s a case of how different firms represent their SFT transactions. So achieving a standard representation of transactions becomes part of the challenge.
What is needed is a standard industry representation of each of the data fields – this would drive improved data quality and data consistency.
Regulation Asia: How would you compare these challenges with what you’ve seen in the derivatives industry?
Williams: The derivatives industry is a little bit more harmonised now because we've been reporting for a number of years globally. But the SFT market has had less of a push towards the harmonisation of flows and standards.
Particularly for Asia, SFTR is a big change for firms as all of a sudden they will need to go and look at these flows and try to understand where some of the discrepancies are. So it’s really around how to drive booking standards, product taxonomies, and how to create those common data domain models which everyone complies with in order to help drive further consistency of representation of products and processes.
Wotton: Another difference on the derivatives side is that there were a number of trade confirmation matching platforms to help address these kinds of challenges. But in the SFT market, the reality is that there aren't the same kinds of volume of matching platforms as the derivatives market had.
That said, we are seeing partnerships form (TRAX and EquiLend; IHS Markit and Pirum Systems) to address these very issues, such as by offering pre-matching services, enabling the generation of a UTI before the counterparties go to report.
Matching is extremely important to ensure continuity of settlement for underlying trades and prevent trade failures, but it also helps to enhance and improve reporting.
Another point worth making is that the SFT and repo market has generally not automated or optimised very much in recent years. With this in mind, SFTR actually presents an opportunity to automate processes, drive more efficiency in booking models, and improve overall end-to-end pricing.
But that depends on whether firms are investing the time to address the required changes strategically, rather than leaving it to the last-minute.
Regulation Asia: What do you see as the strategic solutions firms should be looking at now?
Wotton: I would look at areas around automation, where firms can make investments in their internal systems to drive reporting efficiency, so they will not have to piece together multiple files manually to produce their reporting output.
There are also specific solutions that are helping to solve some of the upstream issues, especially around the generation of the UTI, for example.
But I think that if people just look at it narrowly and see SFTR as just a reporting requirement they are missing something. Yes, it is a reporting requirement, but the knock-on effect is the whole post-execution process and structure will have to change significantly so that firms are in a position to be able to report effectively.
Regulation Asia: How does all of this affect local Asian firms which are not in fact obliged to report under SFTR? Would their relationships with more global counterparties be affected?
Williams: The relationships will be impacted to the extent that some of the information required may be more onerous. The local counterparties may find themselves needing to provide certain pieces of information that in the past they haven’t, and they may find some of their trade flow processes change by default because of some of the changes that firms are having to make to enable SFTR reporting.
So that’s why we believe it may have a broader impact than is currently anticipated.
Wotton: For the local counterparties, it will be more about helping the firm that is impacted to be able to provide all of the data points that are required by the regulation. That will probably be the issue.
For example, if a local counterparty doesn’t have an LEI, that’s going to be an issue because you have put the LEI on the transaction for SFTR reporting purposes.
Regulation Asia: Have you noticed any interest from other regulators in implementing similar rules for SFT reporting in Asia?
Williams: I think this potentially depends on where the activity lies. Japan has some rules implemented for direct reporting to the BOJ (Bank of Japan). But outside of Japan, the repo market is relatively small. Australia would be the biggest market outside Japan.
The RBA (Reserve Bank of Australia) already has some reporting in place – not directly related to SFTR – but it includes similar sorts of data points captured for some repo flows. So we can envisage that Australia’s regulators may have some interest in this.
I would imagine that most jurisdictions would wait to see what happens in Europe, and then wait to see if the US adopts a similar framework. If the US goes live with SFT reporting, then Australia may consider something similar.
Regulation Asia: On a final note, what are some of the other challenges we should be aware of?
Wotton: There is the current process of agent lender disclosures that present possible issues. Typically, certain agent lenders don't disclose the underlying beneficiaries to the trade until after settlement. This won’t work in an SFTR regime because of the T+1 timeline associated with the reporting requirement.
Agent lenders would typically disclose the beneficiaries – for example, a sovereign wealth fund – to their credit risk department, but not to the trading businesses until a few days later. So how do you get the trade reported under SFTR if it's not booked with the name of the counterparty?
So there are still questions around whether the whole agent lenders disclosure process needs to change.
Williams: Another question that is still out there – though it hasn’t yet been evidenced in Asia – involves the costs SFTR will bring. If compliance costs get passed on to the beneficiaries, who are essentially lending stocks or securities, the question is whether it impacts their willingness to potentially lend securities in certain markets.
While there are currently no expectations, it is important to understand that the regulation could create some liquidity issues.
Val Wotton is DTCC's Managing Director of Product Development and Strategy, Derivatives and Collateral Management; Oliver Williams is the Head of DTCC Data Repository, Singapore Pte Ltd, the Singapore based subsidiary of DTCC's trade repository business.