European Union: Securities Financing: Reuse Obligations Become Effective

Last Updated: 21 November 2016
Article by Eoin O’Connor, Garry Ferguson, Gayle Bowen, Paul Farrell, Aaron McGarry, David McGovern, Noeleen Ruddy, Ken Rush, Ailís Garvey and Andrew Traynor

Most Read Contributor in Cayman Islands, March 2019

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.


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.

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