ESMA has published an amendment to Q&A no.2 on “Reporting of settlement fails” but unfortunately it leaves as many outstanding questions as answers.
An out of the blue requirement
Securities Financing Transaction (SFT) markets, the repo market in particular, operate on the basis of perfect settlement. At most firms, there is no feedback loop between settlement systems and SFT risk management systems to enable firms to reliably capture the fact that a transaction closing leg is failing. Therefore, many firms have lacked the technical ability to disconnect their SFTR reporting from their risk management books and records, and report fails in accordance with the regulation. This seemed an out of the blue requirement when it first appeared in the ESMA SFTR Guidelines document in January 2020 and many firms still struggle or fail to meet this requirement as it stands today.
As a result of the consternation expressed by the industry regarding this requirement, ESMA felt the need for reiteration in the first set of SFTR Q&A published in November 2020. This month, ESMA has quietly revised this Q&A further, giving additional guidance and clarifying expectations for SFT markets outside the repo market.
So what does it say?
The primary expectation is that if one or both parties to the transaction have failed to report an amended maturity date/end date to reflect the failing status of the transaction, then both parties will agree a new UTI and book a new transaction to reflect the risk that ESMA perceives to be outstanding. Unfortunately, ESMA neglects to mention what a party who has correctly reported an amendment to the original transaction should do, nor what start date/value date to use on this new hypothetical transaction.
In addition, ESMA reiterates that reporting of settlement fails of the closing leg applies to all types of SFT. ESMA also states that this applies to CCP-cleared SFTs, providing any settlement fails are attributable to individual SFTs.
So all in all, this Q&A update is a missed opportunity from ESMA to truly clarify exactly what its expectations are of the industry, leaving many firms still struggling to adhere to this rather onerous requirement.