Securities financing transaction (SFT)
European Union Electricity Market Glossary

 


 

 

 

Pursuant to Article 3(11) of the Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (SFTR) 'securities financing transaction' or 'SFT' is:

 

(a) a repurchase transaction (including reverse repurchase transaction);

 

(b) securities or commodities lending and securities or commodities borrowing;

 

(c) a buy-sell back transaction or sell-buy back transaction;

 

(d) a margin lending transaction (including margin borrowing transaction).

 

The definition of SFT in the SFTR does not include derivative contracts as defined in the EMIR.

 

However, it includes transactions that are commonly referred to as liquidity swaps and collateral swaps, which do not fall under the said EMIR definition of derivative contracts (Recital 7 of the SFTR).

 

A collateral swap included in the scope involves a securities financing transaction, in which a securities loan is collateralised with non-cash collateral.

 

SFTs can be broadly described as the temporary exchange of cash or securities against collateral.

 

SFTs enable market participants to access secured funding through the temporary exchange of assets as a guarantee for a funding transaction.

 

Banks, like many other types of market participant, use SFTs to increase their leverage by borrowing against their assets as collateral and to enhance liquidity.

 

SFT markets are mainly concentrated in the USA and the EU.

 

Since SFTs involve direct borrowing from counterparties, these transactions are generally accounted on the entities' balance sheets and captured in financial leverage ratios.

 

As such the use of SFTs can present risks, including from maturity transformation (Report on securities financing transactions and leverage in the EU Report prepared under the mandate in Article 29(3) SFTR, 4 October 2016, ESMA/2016/1415, p. 7, 14 and 25).

 

Although SFTs differ in many aspects, they have similar economic effects. 

 

SFTs can be classified into three broad categories: repos, securities lending, and margin lending.

 

Fatures differentiating distinct groups of the SFTs are the size of relevant markets, the purpose of the transactions, the nature of collateral exchanged, the type of market participants, and existing market practices.

 

 

Collaterals and haircuts in SFTs

 

 

In Europe, SFTs account for more than 80% of collateral flows in large EU banks (ESMA Working Paper No. 1, 2017, Collateral scarcity premia in Euro area repo markets, Massimo Ferrari, Claudia Guagliano, Julien Mazzacurati, June 2017, ESMA/2017/ WP-2017-1, p. 4).

 

SFTs are secured (i.e. collateralised) transactions that involve the temporary exchange of cash against securities, or securities against other securities. If the collateral giver defaults, the collateral taker retains the collateral to cover the potential losses.


Collateralisation in the EU is defined in the Directive on financial collateral arrangements (FCD). Two types of financial collateral arrangements are defined in Articles 2(1)(b) and 2(1)(c). The first one is "title transfer financial collateral arrangement" in which a collateral provider transfers full ownership of the collateral to the collateral taker (this includes repos and securities lending arrangements). The second one is "security financial collateral arrangement" where a collateral provider provides financial collateral by way of security to a collateral taker, but the full ownership of the financial collateral remains with the collateral provider when the security right is established. In that second case, a right-of-use clause might apply. In that context right of use means the right of the collateral taker to use and dispose of financial collateral.

 

Report on securities financing transactions and leverage in the EU Report prepared under the mandate in Article 29(3) SFTR, 4 October 2016, ESMA/2016/1415, p. 12

 

Collateral assets in SFTs are typically reused by the EU banks (on average once).

 

Moreover, in most SFTs, collateral takers are only obliged to return “equivalent” assets, i.e. assets that are deemed to be the same on balance sheet (Final Report, Technical standards under SFTR and certain amendments to EMIR, 31 March 2017, ESMA70-708036281-82). 

 

This fungibility of financial assets can make it difficult, if not impossible, for institutions to track collateral reuse.

 

As collateral is at the centre of SFTs, the valuation of collateral can affect the SFT market significantly.

 

Usually, collateral is valued at a discount.

 

The degree of the discount depends on several factors including, but not limited to, liquidity risks, counterparty risks and the volatility of the collateral, and its price correlation with the lent securities.

 

The discount is usually referred to as a “haircut”.

 

Depending on the risks, the haircut can differ substantially from one asset to another. Typically, government bonds’ haircut is less than 5 per cent.

 

The haircut for non-government bonds depends on issuer risk and concentration limit. Based on a recent survey by the International Capital Market Association (ICMA), the median of a corporate bond (with 6 years to maturity) is 5.0 per cent, while for a high-yield bond, it is 20.3 per cent.

 

 

Requirements of Commission Delegated Regulation (EU) 2017/565 of 25 April 2016

 

 

It is noteworthy, written agreement concluded by the investment firms providing any investment service or the ancillary service referred to in Section B(1) of Annex I to MiFID II Directive to a client must include amongst others "the terms on which securities financing transactions involving client securities will generate a return for the client" (Article 58(c) of the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive).

 

 

Article 49(7) of the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive


An investment firm, before entering into securities financing transactions in relation to financial instruments held by it on behalf of a client, or before otherwise using such financial instruments for its own account or the account of another client shall in good time before the use of those instruments provide the client, in a durable medium, with clear, full and accurate information on the obligations and responsibilities of the investment firm with respect to the use of those financial instruments, including the terms for their restitution, and on the risks involved.

 

The said Regulation 2017/565 of 25 April 2016 in Article 63(2)(b) and (c) requires, moreover, that the statement of client assets, which investment firms holding client financial instruments or client funds send to the client at least on a quarterly basis, must include, amongst others, the following information:

 

- the extent to which any client financial instruments or client funds have been the subject of securities financing transactions;

 

- the extent of any benefit that has accrued to the client by virtue of participation in any securities financing transactions, and the basis on which that benefit has accrued.

 

Article 49(7) of the Commission Delegated Regulation 2017/575 of 25 April 2016 contains important requirements regarding information concerning safeguarding of client financial instruments or client funds, which apply to securities financing transactions (see box).

 

 

 

 

 

Although they have economically equivalent effects, SFTs differ greatly in the size, purposes and market practices they serve in EU financial markets, with different implications in terms of procyclicality risks.

  

EU SFT markets are very large. Industry surveys put the gross amount of outstanding repos by European counterparties at around EUR 5.5tn, and the global amount of securities on loan at EUR 1.8tn.

 

The latter includes around EUR 500bn in EU securities on loan.

 

However, the differences in the coverage and definitions of available data imply that the figures used in the report are not directly comparable.

 

This, together with the absence of data on margin lending, implies that there is currently no comprehensive estimate of the size of EU SFT markets or volumes of SFTs in the EU.

  

The broad shift away from unsecured funding since 2008 and some of the regulatory changes introduced since the crisis have resulted in growing importance of collateral for the EU financial system.

 

According to the ECB, quarterly turnover in unsecured Euro money markets declined from EUR 15.3tn in 2007 to EUR 2.8tn in 2015, in part compensated by an increase in the turnover of secured transactions (SFTs) and derivatives.

 

For the largest European banks, SFTs are also the main choice of instruments in terms of collateral flows, with the collateral posted in repos and received from reverse repos adding up to EUR 5.8tn, compared with collateral posted in and received from derivatives of EUR 340bn (ESRB, 2014).

 

Report on securities financing transactions and leverage in the EU Report prepared under the mandate in Article 29(3) SFTR, 4 October 2016, ESMA/2016/1415p. 42

 

 

 

 

 

Recital 10 of the Commission Delegated Regulation (EU) 2017/576 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the annual publication by investment firms of information on the identity of execution venues and on the quality of execution

 

In order to comply with the legal obligation of best execution, investment firms, when applying the criteria for best execution for professional clients, will typically not use the same execution venues for securities financing transactions (SFTs) and other transactions. This is because the SFTs are used as a source of funding subject to a commitment that the borrower will return equivalent securities on a future date and the terms of SFTs are typically defined bilaterally between the counterparties ahead of the execution. Therefore, the choice of execution venues for SFTs is more limited than in the case of other transactions, given that it depends on the particular terms defined in advance between the counterparties and on whether there is a specific demand on those execution venues for the financial instruments involved. It is therefore appropriate that investment firms summarise and make public the top five execution venues in terms of trading volumes where they executed SFTs in a separate report so that that a qualitative assessment can be made of the order flow to such venues. Due to the specific nature of SFTs, and given that their large size would likely distort the more representative set of client transactions (namely, those not involving SFTs), it is also necessary to exclude them from the tables concerning the top five execution venues on which investment firms execute other client orders.

 

 

 

 

Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics, ESMA35-43-349

 

Question 15 [Last update: 10 July 2017]


 

Do the RTS 27 reporting requirements apply to Securities Financing Transactions (SFTs)?

 

Answer 15


Article 1(5)(a) of MiFIR, subsequent to amending Regulation (EU) 2016/1033 of 23 June 2016, states that SFTs are not subject to the pre and post trade transparency obligations set out in Title II and III of MiFIR. While no specific exemption was included with respect to the RTS 27 best execution reporting obligations, Recital 10 of RTS 27 refers to the need for regulatory consistency between its requirements and those on post trade transparency. In this context, ESMA considers that the best execution reporting requirements set out in RTS 27 should not apply to SFTs.


ESMA wishes to make clear that, irrespective of the above clarification concerning the application of RTS 27 to SFTs, the MiFID II best execution requirements otherwise apply to investment firms when carrying out SFTs.


ESMA also wishes to clarify that while RTS 27 would not apply to SFTs, this would not lead to a complete absence of execution quality reports for SFTs, as RTS 28 explicitly requires investment firms to report, inter alia, on order routing behaviours specifically with respect to SFTs and to provide a summary on the quality of execution obtained. Investment firms should also note that RTS 28 already makes specific reference to how data concerning SFTs should be published.

 

 

 

 

 

 

IMG 0744

    Documentation    



 

 

 

Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (SFTR)

 

Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive

 

Report on securities financing transactions and leverage in the EU Report prepared under the mandate in Article 29(3) SFTR, 4 October 2016, ESMA/2016/1415

 

Consultation Paper Draft RTS and ITS under SFTR and amendments to related EMIR RTS, 30 September 2016, ESMA/2016/1409  

 

Commission Delegated Regulation (EU) 2017/576 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the annual publication by investment firms of information on the identity of execution venues and on the quality of execution

 

ESMA Working Paper No. 1, 2017, Collateral scarcity premia in Euro area repo markets, Massimo Ferrari, Claudia Guagliano, Julien Mazzacurati, June 2017, ESMA/2017/ WP-2017-1 

 

Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics, ESMA35-43-349 

 

 

 

 

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Last Updated on Thursday, 14 September 2017 19:37
 

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