Securities Financing Transactions Regulation
The Securities Financing Transactions Regulation (2015/2365) (“SFTR”) entered into force on 12 January 2016 – although in practical terms (subject to one exception) there are no immediate obligations arising under the SFTR aside from preparatory work.
In brief the SFTR concerns the reporting and transparency of securities financing transactions (“SFT”) and imposes conditions relating to the reuse (rehypothecation) of financial instruments received under a collateral arrangement.
Article 3(11) defines a SFT as:
- a repurchase transaction;
- securities or commodities lending and securities or commodities borrowing;
- a buy-sell back transaction or sell-buy back transaction; or
- a margin lending transaction.
For the avoidance of doubt, the definition of a SFT does not include derivative contracts that are reportable under EMIR (recital 7).
Counterparties (a term, which like EMIR, includes ‘financial counterparties’ and so includes, but is not limited to, MiFID investment firms, credit institutions, AIFs, UCITS etc. – but please refer to Article 3 for the definition – and ‘non-financial counterparties’) are required to report the details of any SFT that they have concluded to a trade repository no later than the following working day. Where either an AIF or a UCITS that is managed by a management company are the counterparties to STFs then the AIFM and the management company, as applicable, will be responsible for the reporting obligation. Please see Article 4 for details of the reporting requirements.
The reporting requirement applies to a counterparty established in the EU (including all its branches irrespective of where they are located) and to third-country established entities if the SFT is concluded by an EU branch of that counterparty.
ESMA is charged with developing draft regulatory technical standards (“RTS”) specifying the details of the reports for the different types of SFTs (but see Article 4(9) for the minimum content) so as to ensure, not only consistency of application of the reporting obligation, but also consistency with reporting made under EMIR. ESMA will also be responsible for drawing up draft implementing technical standards (“ITS”) on the frequency and format of the reports. The effect of Article 33(2)(a) is that reporting will be phased in over a period of 12 to 21 months (depending on counterparty type) after entry into force of the RTS – ESMA is required to submit the draft RTS (and ITS) to the European Commission by 13 January 2017.
The reporting obligation will apply to some SFTs that were concluded before the reporting obligation applies if they remained outstanding at that time – see Article 4(1)(a).
Note from Article 4(3) the circumstances when a financial counterparty is responsible for reporting on behalf of a non-financial counterparty as well as for itself.
Article 13 requires UCITS investment companies/management companies and AIFMs to inform investors on the use they make of SFTs and total return swaps. The disclosures must appear in the half yearly and annual reports for UCITS and in the annual reports in respect of AIFs. The information to be included can be found in Section A of the Annex – although ESMA may develop draft RTS for further specifying the content.
The requirement applies from 13 January 2017 (Article 33(2)(b)).
A UCITS prospectus and the pre-investment disclosure by AIFMs will be required to specify the SFT and total return swaps that are authorised to be used and include a clear statement that those transactions and instruments are used (Article 14). The data to be included can be found in Section B of the Annex.
The requirement for funds that are constituted before 12 January 2016 applies from 13 July 2017. However the requirement applies with immediate effect to all funds constituted after 12 January 2016 (Article 32(2)(c)).
Reuse of financial instruments received under a collateral agreement
Any right of counterparties to reuse financial instruments, as defined in Section C of Annex I of Directive 2014/65 (‘MiFID 2’), must be subject to at least the following conditions:
- the providing counterparty has been informed in writing by the receiving counterparty of the risks and consequences of one of the following:
- granting consent to a right of use of collateral
- concluding a title transfer collateral arrangement
- the providing counterparty has granted its prior express consent, as evidenced by a signature in writing or in a legally equivalent manner, to the reuse of such collateral.
Any exercise by counterparties of their right to reuse must only be undertaken in accordance with the arrangement referred to in the second bullet above and the financial instruments involved must be transferred from the account of the providing counterparty.
The ‘reuse’ obligation applies to
- a counterparty established in the EU (including all its branches irrespective of where they are located); and
- third-country established entities where either the reuse is effected by an EU branch of that counterparty or the reuse concerns financial instruments under an arrangement by a counterparty established in the EU or a branch in the EU of a third-country counterparty.
See Article 15 for further details.
The requirement applies from 13 July 2016, including for collateral arrangements existing on that date (Article 33(2)(d)).
As mentioned above, a SFT excludes a derivative contract that is reportable under EMIR. However, whilst not reportable as a SFT, a total return swap, which is an OTC derivative, features in the transparency requirements under the SFTR. In order to ensure coherency in the scope of both sets of transparency and reporting requirements, the SFTR amends EMIR and the definition of OTC so that the same types of derivative contracts are identified as either OTC or exchange-traded irrespective of whether they are traded in the EU or in third-country markets – see recital 42 and Article 32.