The Council of the EU formally adopted the Securities Financing Transactions Regulation (SFTR) on 16 November 2015, which will form part of the EU’s package of legislation targeted at reforming shadow banking and aims to improve transparency in the securities financing transactions (SFT) market.
The SFTR is expected to be published in the Official Journal of the EU shortly and will enter into force 20 days after its publication.
Set out below is an outline of the SFTR’s scope, its requirements and the dates by which those requirements are to take effect. Given that the requirements relating to the reuse of collateral received are not only confined to SFTs, the SFTR will impact different business areas involving security and title transfer collateral arrangements, including those providing derivatives and prime brokerage services.
Key requirements imposed by the SFTR include:
- counterparties to an SFT having to (i) report the SFT’s details to a trade repository upon its conclusion, modification and termination; and (ii) keep records of the SFT for at least five years following its termination;
- a party reusing financial instruments received under a collateral arrangement having to (i) first disclose the risks and consequences and obtain written consent; and (ii) only exercise its right to reuse in accordance with the collateral arrangement’s terms and only with respect to financial instruments that have been transferred from the providing counterparty’s account; and
- managers of undertakings for collective investment in transferable securities (UCITS) and alternative investment fund managers (AIFMs) having to disclose their use of SFTs and total return swaps to investors in their half-yearly and annual reports and in their pre-investment disclosures.
Scope of ‘SFTs’ and ‘Reuse’
‘SFTs’ comprise repurchase transactions, securities and commodities lending and borrowing transactions, buy/sell-back and sell/buy-back transactions and margin lending transactions. The inclusion of margin lending extends the scope of the SFTs to transactions beyond the scope of those traditionally considered as SFTs.
‘Reuse’ refers to the use by a receiving counterparty, in its own name and on its own account or on the account of another counterparty, of financial instruments received under a title transfer or security collateral arrangement.
The SFTR’s territorial scope reaches beyond the EU. As well as applying to an EU entity that is party to an SFT (for the purpose of the SFT reporting requirements) or engaging in reuse (for the purpose of the reuse requirements), the SFTR applies to:
- an EU entity’s non-EU branch that is party to an SFT or engaging in reuse; and
- a non-EU entity that is party to an SFT or engaging in reuse, if (i) the SFT is concluded or the reuse is effected by that non-EU entity’s EU branch; or (ii) the reuse concerns financial instruments provided under a security or title transfer collateral arrangement by an EU counterparty or EU branch.
Non-EU entities will, therefore, have to have systems in place to monitor which of the financial instruments that they intend to reuse have been provided by an EU counterparty or by an EU branch of a non-EU entity.
Scope of entities
Whilst there are additional obligations imposed specifically on UCITS managers and AIFMs to disclose information to investors on the use of SFTs and total return swaps, the SFT reporting and reuse requirements apply to both financial counterparties and non-financial counterparties.
However, the SFT reporting and reuse requirements do not apply to certain counterparties, such as members of the European System of Central Banks, and there are certain exceptions for non-financial counterparties (as set out below).
SFT reporting requirements
Similar to the reporting obligation imposed on counterparties to derivatives under the European Markets Infrastructure Regulation (EMIR), the SFTR imposes an obligation on both counterparties to an SFT to report details of the transaction to a trade repository within one working day of the transaction’s conclusion, modification or termination.
Parties required to report
Although both counterparties have an obligation to report the details of an SFT, a financial counterparty is responsible for reporting the details on behalf of both counterparties where its counterparty is a non-financial counterparty which on its balance sheet date does not exceed at least two of the thresholds of: (i) a EUR 20,000,000 balance sheet total; (ii) a EUR 40,000,000 net turnover; and (iii) 250 employees on average during the financial year.
Where a UCITS or an alternative investment fund (AIF) is the counterparty to an SFT, the UCITS manager or AIFM shall be responsible for reporting on behalf of the UCITS or AIF. Further, any counterparty subject to the reporting obligation may delegate the reporting.
Details to be reported
It is envisaged that the details of the SFT reports, which will vary for each type of SFT, will be consistent with those provided for derivatives under EMIR. The SFTR specifies the minimum information to be reported, which includes the parties to the SFT, the principal amount, the currency, the assets used as collateral, and whether the collateral is available for reuse.
The European Securities and Markets Authority (ESMA) is required to submit to the European Commission within 12 months of the entry into force of the SFTR (i) draft regulatory technical standards (RTS) specifying the details to be reported; and (ii) draft implementing technical standards (ITS) specifying the format and frequency of the reports. As part of ESMA’s consultation on these draft RTS and ITS, we would encourage clients to engage with ESMA so as to ensure that the reporting requirements are consistent with how transactions are actually carried out in operational practice, for instance where collateral is provided on a pooled basis.
Parties must keep records of any SFTs that they have concluded, modified or terminated for at least five years following the termination of the transaction.
Disclosure and consent requirements
A counterparty shall only be allowed to reuse financial instruments received under a title transfer or security collateral arrangement if it first:
- discloses to the providing party the risks and consequences of either (i) granting a right of use of collateral provided under a security collateral arrangement; or (ii) concluding a title transfer collateral arrangement; and
- • obtains the providing party’s (i) express written consent to a security collateral arrangement that includes a right of reuse; or (ii) express agreement to the provision of collateral under a title transfer collateral arrangement.
During the six months after the entry into force of the SFTR until the reuse requirements are to take effect, counterparties will need to adapt their collateral arrangements, including derivatives and SFT master agreements and prime brokerage agreements, to ensure that they comply with the new reuse requirements. Although under the current UK regime, prime brokers are required to disclose to clients the key risks arising from their assets being reused, the scope of disclosure required under the SFTR may be broader.
Restrictions on the right of reuse
A counterparty can only exercise its right to reuse if the reuse undertaken is in accordance with the original security collateral arrangement or title transfer collateral arrangement and if the financial instruments received under the arrangement are first transferred from the account of the providing counterparty.
UCITS and AIF disclosure requirements
UCITS management companies, UCITS investment companies and AIFMs must disclose certain specified information to investors about their use of SFTs and total return swaps.
Half-yearly and annual reports
The use of SFTs and total return swaps must be disclosed by (i) UCITS management and investment companies in their half-yearly and annual investor reports required under the UCITS IV Directive; and (ii) AIFMs in their annual investor report required under the AIFM Directive. ESMA is empowered to specify in draft RTS the detailed information to be disclosed, but the minimum information to be disclosed includes the amount of securities and commodities on loan as a proportion of total lendable assets and the amount of assets engaged in each type of SFT and total return swap expressed as an absolute amount and as a percentage of the fund’s total assets under management.
In the UCITS prospectus required under the UCITS IV Directive and the AIF pre-investment disclosure required under the AIFM Directive, UCITS management or investment companies and AIFMs must specify which SFTs and total return swaps they are authorised to use and include a clear statement that those transactions are used. Examples of information that must be disclosed include a general description of the SFTs and total return swaps used and the maximum and expected proportion of assets under management that can be subject to those transactions. ESMA is empowered to provide draft RTS specifying further details to be disclosed.
Consequences of non-compliance
Member States must empower competent authorities to impose sanctions for at least breaches of the SFT reporting and reuse requirements, including a public statement of censure, the withdrawal of authorisation, a temporary ban against a person discharging managerial responsibilities and a fine up to a maximum of three times the amount of profit gained and loss avoided.
However, a breach of the SFT reporting requirement will not affect the validity or enforceability of the SFT itself.
The SFTR, including the requirement to keep records of any SFTs for at least five years following the transaction’s termination, will enter into force 20 days after its publication in the Official Journal of the European Union, except that certain requirements are to take effect from a later date, as set out in the table below.
Date by which in force
Counterparties to comply with requirements on reuse of collateral (e.g. to obtain express written consent and to disclose the risks and consequence)
6 months after the SFTR’s entry into force
UCITS/AIF disclosure requirements
UCITS and AIFMs to disclose their use of SFTs and total return swaps in their half-yearly and annual reports (as applicable)
12 months after the SFTR’s entry into force
UCITS and AIFMs to disclose their use of SFTs and total return swaps in their prospectus and pre-investment disclosure (as applicable)
18 months after the SFTR’s entry into force for AIFs and UCITs that are already constituted before the SFTR’s entry into force
SFT reporting requirements
Investment firms and credit institutions to report SFTs to a trade depository
12 months after the entry into force of the SFT reporting RTS
Central securities depositories and central counterparties to report SFTs to a trade depository
15 months after the entry into force of the SFT reporting RTS
Insurance/reinsurance undertakings, UCITS/UCITS managers, AIFs/AIFMs and institutions for occupational retirement provision to report SFTs to a trade depository
18 months after the entry into force of the SFT reporting RTS
Non-financial counterparties to report SFTs to a trade depository
21 months after the entry into force of the SFT reporting RTS
Application of SFT reporting requirements to existing SFTs
The obligation to report an SFT to a trade repository will apply to an SFT existing before the date on which the obligation takes effect (as set out in the table above) if (i) the remaining maturity of the SFT exceeds 180 days; or (ii) the SFT has an open maturity and remains outstanding 180 days after that date.
Those SFTs must be reported within 190 days of the relevant date of application.
Application of reuse requirements to existing collateral arrangements
The requirements relating to the reuse of collateral will apply to collateral arrangements existing on the date that the requirements enter into force, that is six months after the SFTR’s entry into force.
Michael Raffan has extensive financial services and regulatory experience, and regularly advises banks, investment banks, securities houses and market infrastructure providers as well as central banks, regulatory authorities and market associations on both domestic and European financial services and regulatory issues. Michael is the Freshfields relationship partner for the Bank of England. He is also one of the co-ordinating partners for the firm’s Recovery and Resolution Plan (RRP) initiative and a regular speaker and author on recovery and resolution.
Mark Kalderon focuses on banking and investment firm regulation and has practised as a partner in the area for more than 15 years. His clients include a number of the largest and most important global commercial and investment banks. He acts for clients on market and conduct of business issues (for both wholesale and retail markets) and prudential regulation, including capital adequacy. He also advises financial institutions on a range of wholesale market activities, including custody, repo, securities lending, and prime brokerage. His practice covers drafting documentation in these areas as well as legal and regulatory advice.
David Rouch works with the full range of financial market participants, on both their advisory and transactional matters – dealing with some of the market’s greatest regulatory challenges. David co-heads the firm’s global asset and wealth management practice. He is also a relationship partner for some of the firm’s largest clients, enjoying the opportunity to get know each of their businesses and taking a holistic approach to ensure that the firm supports their goals. He has served on numerous regulatory and industry working groups established by HM Treasury, the Financial Markets Law Committee and the British Bankers Association among others.
James Smethurst specialises in financial services regulatory matters for both wholesale and retail financial services clients, and has practiced as a partner in this field for nearly 10 years. He has extensive experience in sales- and trading-related issues, including in particular prime brokerage. James has also advised on numerous transactions, including on the group regulatory capital implications of acquisition structures and multi-jurisdictional regulatory approvals. James regularly speaks at client seminars and conferences, and contributes to legal journals and other publications, including the Practitioner's Guide to MiFID and Practitioner's Guide to EU Financial Services Directives.
Alexander Glos advises banks and other financial institutions, and also unregulated entities, on all areas of financial services regulation. He specialises in banking and investment services regulation, as well as payment services and capital markets regulation. Alexander works with financial institutions and investors on M&A and loan portfolio transactions, as well as bank restructurings and other financial market stabilisation measures. His recent experience includes advising two banks with regard to the Comprehensive Assessment by the European Central Bank as well as one bank in relation to a proceeding with the Administrative Board of Review of the European Central Bank.
In twenty-five years in the financial sector, Raffaele Lener has assisted with the drafting of Italian financial and banking laws and worked on the privatisation of many state-owned companies. His clients include banks, insurance companies, financial institutions and various Italian regulatory authorities. He was one of the commissioners in the liquidation of EFIM Group, a liquidator of Banca di Credito di Trieste, a commissioner of Bank Sepah Iran and Banca UBAE (Libya), and a member of the commission for the regulation of independent authorities.
Steven Lightstone focuses on financial services regulatory matters, in both an advisory and transactional context. Before specialising in this field he also spent time advising on derivatives and structured finance transactions more broadly. He has experience acting for a wide range of financial institutions, including investment banks, central banks and regulators, investment firms and insurers, on many different regulatory issues - for example, including the implementation of and compliance with MiFID II, EMIR, CRD IV, AIFMD and the Securities Financing Transactions Regulation.
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