ESMA’s Final Report and SFTR: Have Opportunities to Reduce the Reporting Burden Been Missed?
We recently examined what ESMA’s Final Report means for MiFIR transaction reporting. This article focuses on the SFTR implications.
ESMA’s Final Report on the Call for Evidence on the simplification of transaction reporting sets out the next stage in the EU’s programme to reduce the cost and complexity of reporting.
But for firms subject to SFTR, the picture is less clear. SFTR has now been in operation for six years and remains one of Europe’s most resource-intensive transaction reporting regimes with up to 155 fields and ten reportable action types. Yet many of the changes that could materially reduce that burden have not been taken forward.
There are undoubtedly opportunities within ESMA’s proposals. But the question for the securities financing industry is whether they go far enough – and whether the eventual changes will actually work in the world of SFTs. What follows will be crucial to both the efficient functioning of many market infrastructures, securities financing operations and regulators’ ability to keep tabs on this key, macro-systemically significant market segment.
Key takeaways
- SFTR receives relatively limited relief in ESMA’s Final Report despite the significant cost and operational burden associated with the regime.
- Some considerable opportunities have not been taken forward, particularly around reference data, dual-sided reporting and reconciliation.
- Kaizen estimates that compliance with certain SFTR reference data fields alone can cost a firm up to €100,000 per year – a burden that disproportionately affects smaller firms.
- There are practical alternatives worth considering that could reduce the reporting burden while maintaining and improving data quality.
What does ESMA’s Final Report mean for SFTR?
ESMA has been set an unenviable task in taking forward the EU-wide programme to reduce the burden of financial transaction reporting.
For SFTR, however, the short- to medium-term concessions are relatively limited in the context of it being one of the most resource-intensive transaction reporting regimes in Europe.
One of the biggest potential cost-saving measures is the proposed revision of dual-sided reporting through mandatory delegated reporting. However this is likely to require Level 1 changes and therefore may take a number of years to implement.
ESMA has not retained a full transition to single-sided reporting, arguing that two independent reports allow competent authorities to verify data consistency, identify mismatches and detect potential reporting issues or gaps.
There is a legitimate question about how much genuine independence exists within those two reports today. Once mandatory and voluntary delegated reports are taken into account, alongside reports that are single-sided by jurisdiction and those where fields have been enriched by the same dominant data vendors, the degree of genuine independence can be considerably reduced.
The longer-term ambition of a single reporting regime also raises important practical questions.
There are a relatively limited number of genuinely shared fields between the existing regimes, with areas such as pricing, direction of trade and even parties to a transaction differing significantly between products and legacy regimes.
A single regime could reduce the number of major regulatory change cycles from three to one and potentially allow firms to consolidate some vendor relationships. But how this will work operationally is a very different matter.
It is difficult to imagine a single, non-business-aligned team being able to understand every nuance of a compound multi-regime report, while also dealing with exceptions, back-reporting, rewrites and revisions.
Without careful implementation, firms could conceivably end up with three teams, three sets of systems and one report.
Where has ESMA missed opportunities to reduce the SFTR reporting burden?
There are several areas where more could potentially be done to reduce the cost of SFTR without compromising the information available to regulators.
1. Static and reference data
Instead of “Report Once”, an alternative approach could be:
If a value or attribute does not appear in a firm’s books and records, there should not be a requirement to report it.
Under SFTR, firms are currently required to provide information including CFI codes, security quality, maturity of the security, jurisdiction of the issuer, LEI of the issuer and security type, in some cases on both the loan and collateral side.
For many firms, obtaining this information requires purchasing third-party reference data purely for the purposes of regulatory reporting.
Take “Security Type” and the corresponding “Collateral Type” fields. To establish one of the eight permissible field populations – MEQU (Main Index Equities including convertible bonds) – we estimate that a firm could spend up to €100,000 a year simply obtaining all of the constituents of the EU main indices under EU Regulation 575/2013.
This particularly penalises smaller firms but is not being addressed.
Credit quality creates a similar challenge. Firms without extensive internal credit functions may need to purchase credit ratings for every security that appears, sometimes fleetingly, in a collateral pool.
Yet much of this information is already captured by ESMA under CRAR regulation.
As a result there is a significant opportunity to reconsider which party is best placed to provide this data. Greater regulator adoption of golden sources for static and reference data could reduce costs for firms while potentially improving both data consistency and quality.
2. Dual-sided reporting and reconciliation
The cost of dual-sided reporting and the associated trade repository reconciliation process remains substantial.
ESMA proposes revision through mandatory delegated reporting rather than moving fully to single-sided reporting. That may reduce some of the burden but it leaves open a bigger question: whether the existing model delivers sufficient additional supervisory value to justify its operational cost.
There’s also an important practical consideration. If mandatory delegated reporting leads firms to reduce or disband existing reporting teams, it cannot automatically be assumed that the same controls and information exchange between counterparties will continue in their current form.
The industry therefore needs clarity not only on who physically submits the report but also on where responsibility for its completeness and accuracy ultimately sits.
3. Settlement fails
The proposed treatment of settlement fails under SFTR also illustrates the danger of applying a one-size-fits-all approach across securities financing markets.
Repo and securities lending do not operate in the same way. The repo market operates on a perfect settlement basis with intermediate trade fails requiring the failing party to compensate the other counterparty. But securities lending operates on an actual settlement basis. It’s an important difference that really matters when designing reporting requirements.
Many firms also choose to report close to real time despite the T+1 deadline and source their SFTR reports from risk management rather than settlement systems. Re-engineering those processes around whether a trade has settled could therefore represent a substantial technology and operational project in its own right.
This is precisely the sort of market nuance that needs to be considered if changes intended to reduce reporting burden don’t inadvertently have the opposite effect.
What could be done differently?
There are several practical alternatives that deserve further consideration as the future SFTR framework develops.
- Make greater use of golden-source data
If regulators or other authoritative sources already hold reliable static and reference data associated with an ISIN or other identifier, there is a case for examining whether firms need to source and report that information separately.
- Go further on dual-sided reporting
Mandatory delegated reporting is a step towards reducing duplication but the industry should consider whether a properly designed single-sided model could deliver equivalent supervisory information with materially lower cost.
- Consider open trade or position reporting
There is currently a substantial industry around daily activity reporting under SFTR and EMIR, with multiple reportable activities potentially generated each day and then subject to reconciliation at the trade repository.
An alternative worth considering is an approach closer to the US Office of Financial Research model for non-centrally cleared bilateral repo reporting: a single end-of-day open trade or position report together with the corresponding collateral.
For firms this could be substantially easier and cheaper to produce and it could improve data quality too. Where a competent authority needs to understand what has changed, today’s position can be compared with yesterday’s.
Such an approach would of course involve trade-offs, particularly in relation to the granular detail theoretically possible under the current SFTR model. But that is exactly the kind of cost-benefit discussion the industry should now be having.
Reducing burden without reducing quality
Whatever path ESMA ultimately follows, the onus will remain on reporting counterparties to ensure that their reporting of securities financing transactions is complete, accurate and timely.
Indeed, any meaningful reduction in reporting burden – and any greater transfer of trust to reporting counterparties – is likely to be accompanied by an increased focus on data quality. And this is why the detail is so important.
The objective should not simply be fewer fields or fewer reports. It should be a reporting framework that reflects how securities financing markets actually operate, removes unnecessary duplication (and cost) and still provides regulators with the high-quality data they need.
For SFTR, there remains a significant opportunity to achieve that.
If you would like to discuss your SFTR reporting quality or how best to prepare for the evolving regulatory landscape, please get in touch.
