|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);
(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.
According to the International Capital Market Association’s (ICMA’s) stance, expressed in the letter of 31 January 2017 to the European Commission’s DG FISMA, SFTs are not in themselves financial instruments as defined under MiFID (Annex I, Section C), they are rather types of transactions.
These financing transaction types are defined by negotiable start and end-dates; and different underlying instruments, or baskets of instruments.
Since SFTs are not in themselves financial instruments, ICMA considers that SFTs should be out of scope of the best execution reporting obligations under RTS 27 (RTS 27 relates to transactions in MiFID instruments).
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).
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 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).
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 2017/565 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).
Best execution requirements
Article 1(5)(a) of MiFIR states that SFTs are not subject to the pre and post trade transparency obligations set out in Title II and III of MiFIR.
Moreover, ESMA considers that the best execution reporting requirements set out in RTS 27 (Commission Delegated Regulation (EU) 2017/575 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards concerning the data to be published by execution venues on the quality of execution of transactions) should not apply to SFTs.
The above clarification on RTS 27 notwithstanding, RTS 28 (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) 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.
RTS 28 also makes specific reference to how data concerning SFTs should be published.
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
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
|Last Updated on Thursday, 23 August 2018 22:02|