European Union: Securities Financing: Reuse Obligations Become Effective

The Securities Financing Transactions Regulation (EU 2015/2365) (the "SFTR" or the "Regulation") forms part of the EU initiative on shadow banking and is intended to assist in bringing more transparency to shadow banking activities. The EU Commission, in a factsheet published in October 2015, stated that the shadow banking sector should be better monitored in light of its size, its close links to the regulated financial sector and the systemic risks that it may pose. The Commission identified the reduction of risk associated with securities financing transactions ("SFTs") and increasing transparency as priorities which the introduction of the SFT aims to address and regulators, including ESMA, will be provided with access to detailed, reliable and comprehensive data for the ongoing monitoring of risk in the sector.

The SFTR introduces mandatory reporting for SFTs and sets minimum disclosure and consent requirements on the reuse of collateral. The SFTR came into force on 12 January 2016, with the exception of certain provisions as set out in Article 33. The reuse requirements (detailed below) are the most recent obligations to come into effect – in force from 13 July 2016.

Overview: Scope and Key Requirements

SFTs are transactions that allow counterparties to use their assets as a source of funding, for liquidity and collateral management and for the execution of investment strategies. They are defined in the Regulation as:

  • repurchase transactions;
  • securities or commodities lending and securities or commodities borrowing;
  • buy sell-back or sell buy-back transactions; and
  • margin lending transactions.

Derivatives contracts as defined in EMIR are outside the scope of the FTR. The Regulation effectively imposes three key obligations in relation to SFTs:

  • The Reporting Obligation: the Regulation introduces mandatory record keeping and reporting to trade repositories for all SFTs. The obligation to report is imposed on both parties to the trade (subject to certain exceptions outlined below);
  • The Disclosure Obligation: managers of UCITS and AIFs will be required to disclose details of the use of SFTs and total return swaps ("TRSs") in prospectuses and in periodic reports; and
  • The Reuse Obligation: transparency conditions are imposed in relation to the reuse of collateral including requirements relating to risk disclosure to counterparties and obtaining express consent in advance of rehypothecation or reuse of assets.

These obligations are imposed on the following:

  • counterparties to an SFT that are established:

    • in the EU, including all its branches irrespective of branch location (so non-EU branches are in scope);
    • in a third country, if the SFT is concluded in the course of the operations of an EU branch of that counterparty;
  • UCITS management companies and investment companies;
  • AIFMs authorised or registered under AIFMD; and
  • For the purposes of the Reuse Obligation, counterparties that are;

    • an EU entity;
    • a branch of an EU entity; or
    • a non-EU entity if (i) the reuse is effected in the course of the operations of its EU branch; or (ii) the reuse concerns financial instruments provided under a collateral arrangement by a counterparty established in the EU or an EU branch of such counterparty.

Counterparties are categorised as financial counterparties ("FC") or non-financial counterparties ("NFC"). FCs are defined as investment firms, credit institutions, insurance and reinsurance undertakings, UCITS and, where relevant, their management companies, AIFs managed by AIFMs registered or authorised under AIFMD, central clearing counterparties authorised under EMIR, central securities depositories authorised under the CSDR and non-EU entities that would be regulated as any of the foregoing if established in the EU. NFCs are undertakings established in the EU or in a third country that are not FCs and will include special purpose vehicles ("SPVs") incorporated in Ireland that enter into SFTs. Members of the European System of Central Banks, Member States' public bodies performing similar functions or charged with or intervening in the management of public debt and the Bank of International Settlements are all explicitly excluded from the scope of the Regulation.

Reporting Obligation

Article 4(1) of the SFTR provides that, with certain exceptions (detailed below), both parties will be obliged to report the details of any SFT concluded, modified or terminated by them to a registered or recognised trade repository no later than the next working day. The Reporting Obligation may be delegated by a counterparty, although regulatory responsibility will remain with that entity.

By way of exception to Article 4(1), the SFTR provides that UCITS management companies will be responsible for reporting on behalf of their UCITS and AIFMs on behalf of their AIFs. NFCs that fall into the category of "medium sized undertakings" under the Directive on Financial Statements will not have to report their SFTs with FCs. The obligation to report those SFTs will fall on the FC counterparty, which must report on behalf of both parties. Where a trade repository is not available to record the details of the SFT, the report may be made to ESMA.

The Reporting Obligation is broadly similar to the reporting framework for derivatives under EMIR and it is expected that industry standard delegated reporting agreements and processes will be agreed and implemented. A review of the reporting process will be undertaken by the Commission in consultation with ESMA within 3 years of the date of entry into force of the regulatory technical standards (the "RTS") under the SFTR to assess whether reporting should be improved.

The draft RTS were published by ESMA on 11 March 2016 and the start date for the Reporting Obligation will vary on the basis of the category

of counterparty as detailed in the table below.

Category of Counterparty Sub-category of Counterparty (including non-EU equivalent entities) Phase-in of Reporting Obligation
FC Investment firms and credit institutions 12 months after ESMA's reporting RTS enter into force
FC Central clearing counterparties and central securities depositories 15 months after ESMA's reporting RTS enter into force
FC AIFs, UCITS and all other FCs 18 months after ESMA's reporting RTS enter into force
NFC All (subject to exemptions for medium sized undertakings) 21 months after ESMA's reporting RTS enter into force

The content of an SFT report will also depend of the type of SFT, however the SFTR sets out minimum requirements for reporting, stating that the information provided should include the parties to the SFT, the principal amount, the currency, the assets used as collateral and their type, whether collateral is available for reuse, the repurchase rate, lending fee or margin lending rate, any haircut, the value date, maturity date, the first callable date and the market segment. In March 2016 ESMA issued a draft discussion paper dealing with, amongst other things, the proposed data for reporting, with the related industry consultation closing on 22 April 2016. A consultation paper including draft RTS and ITS was published on 30 September of this year and responses will be accepted until 30 November 2016.

Counterparties will be obliged to retrospectively report SFTs entered into prior to the entry into force of the reporting RTS in instances where the SFT has (a) a remaining maturity of at least 180 days following the relevant start date; or (b) an open maturity and does in fact remain outstanding for at least 180 days after the relevant start date.

Records of any SFT concluded, modified or terminated must be kept by counterparties for a period of at least five years following the termination of the transaction, and this record keeping obligation applied from the date the SFTR entered into force on 12 January 2016.

Disclosure Obligation

UCITS management companies, UCITS investment companies and AIFMs will be obliged to disclose to investors their use of SFTs and TRSs both periodically (in their financial reports) and on a pre-contractual basis (e.g. in pre contractual document such as prospectuses or offering memoranda).

Periodic Disclosure

Section A of the Annex to the SFTR sets out the information that must be included in annual and half-yearly reports, including global data, concentration data (i.e. the ten largest collateral issuers across all SFTs and TRSs and the top ten counterparties of each type of SFT and TRS), aggregate transaction data for each type of SFT and TRS, data on reuse of collateral, information on the safekeeping of collateral received or granted and data on the return and cost for each type of SFT and TRS.

Periodic disclosure requirements will be applicable 12 months after the SFTR comes into force, on 12 January 2017.

Pre-Contractual Disclosure

The information that must be included in prospectuses/offering documents/disclosure documents is set out at Section B of the Annex and includes a general description of the SFTs and TRSs used and the rationale for their use, overall data to be reported for each type of SFT, the criteria used to select counterparties, a description of acceptable collateral and of the valuation methodology, description of risks linked to SFTs and TRSs, details of safe-keeping, restrictions on collateral reuse and policy on sharing of return generated by SFTs and TRSs.

Pre-contractual disclosure requirements have been applicable to funds constituted on or after 12 January 2016 since that date, while older funds will have an 18 month period commencing from 12 January 2016 to amend their existing pre-contractual and disclosure documents for compliance with the Disclosure Obligation.

Entities that are not UCITS funds, UCITS management companies or AIFMs are not subject to this obligation, and so SPVs are out of scope in this context.

Reuse Obligation

The Reuse Obligation is imposed upon the same types of counterparties that are subject to the Reporting Obligation and requires certain formalities to be met before a counterparty is permitted to reuse collateral. For the purposes of the SFTR, "reuse" means the use by a receiving counterparty, in its own name and on its own account or on the account of another counterparty, of financial instruments received under a collateral arrangement, comprising transfer of title or exercise of a right of use in accordance with the Financial Collateral Directive. The requirements mean that:

  • the counterparty providing collateral (the "providing counterparty") must be informed in writing by the counterparty receiving collateral (the "receiving counterparty") of the risks and consequences associated with granting consent to reuse collateral, and in particular the risks and consequences that may arise in the event of a default of the receiving counterparty; and
  • the providing counterparty must grant its prior consent in writing to the reuse of collateral under a security collateral arrangement or must have expressly agreed to provide collateral by way of a title transfer arrangement with a right of reuse.

A counterparty is entitled to exercise the right to reuse where the following criteria are met:

  • the reuse is undertaken in accordance with the terms of the collateral arrangement; and
  • the financial instruments received under a collateral arrangement are transferred from the account of the providing counterparty to an account opened in the name of the receiving counterparty

The SFTR supplements the Financial Collateral Directive and states explicitly that the Reuse Obligation will not affect national law concerning the validity or effect of a transaction. The requirements of the SFTR are without prejudice to legislation that contains stricter provisions (like AIFMD and the UCITS Directive) and national legislation that provides higher levels of protection to counterparties.

The Reuse Obligation came into effect on 13 July 2016 and applies to new collateral arrangements entered into after that date as well as to existing arrangements. As with the other obligations under the SFTR, the Reuse Obligation has extraterritorial effect and applies to non-EU counterparties receiving collateral from counterparties in the EU.

The Association for Financial Markets in Europe, FIA, the International Capital Market Association, the International Swaps and Derivatives Association, Inc. and the International Securities Lending Association have jointly published a statement that can be used to help market participants comply with Reuse Obligation. The statement informs market participants of the general risks and consequences that may be involved in consenting to a right of use of collateral provided under a security collateral arrangement or of concluding a title transfer collateral arrangement. Market participants can tailor the statement to suit their circumstances.

Compliance and Sanctions

Counterparties that are within the scope of the SFTR will need to put the appropriate internal policies in place to ensure compliance with the obligations outlined and enable employees to report breaches of the Reporting and Ruse Obligations to the competent authority (in Ireland, the Central Bank).

Member States are required to implement effective administrative sanction regimes for the purposes of the SFTR which will at least deal with breaches of the Reporting and Reuse Obligations. Irish legislation dealing with enforcement and sanctions has not yet been published, although the Regulation provides that maximum monetary fines must be at least:

  • €5 million or 10% of annual turnover for breaches by a legal person of the Reporting Obligation; and
  • €15 million or 10% of annual turnover for breaches by a legal person of the Reuse Obligation.

Conclusion

UCITS management companies and their investment companies, AIFMs, SPVs and any other counterparties to an SFT will need to ensure that they are prepared for effective compliance with the most recently introduced obligation – the Reuse Obligation - and will be in a position to make the necessary reports in relation to relevant SFTs when the Reporting Obligation is phased in for the category of counterparty into which they fall.

As part of the EU's strategy for reform of the shadow banking sector, the SFTR is just one of a range of regulatory initiatives aimed at increasing transparency and regulatory oversight and reducing risk in securities financing markets, including EMIR, MiFID II and AIFMD. Market participants will need to consider how requirements under the SFTR will be integrated into their implementation projects for these regulatory instruments and, in conjunction with industry bodies, focus on formulating standardised methods of compliance and addressing issues such as confidentiality and the delegation of reporting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions