EUROPEAN UNION: EC Publishes Report Concerning the Transparency of Security Financing Transactions

Tuesday October 24 2017

On the 19^th of October, the European Commission (EC) issued a report concerning the transparency of securities financing transactions and of reuse (SFTR) under Regulation (EU) 2015/2365.

Regulation (EU) 2015/2365 on the transparency of securities financing transactions and of reuse (SFTR) aims to get a better understanding of the effects of shadow banking (non-bank credit intermediation) and to address the risks posed by securities financing transactions (SFTs).

SFTs are secured funding or lending transactions that imply a temporary exchange of assets with one leg of the transaction serving as a guarantee (collateral). Repurchase agreements (repos) constitute the most important category of SFTs in terms of outstanding amounts and turnover. They are generally motivated by the need to borrow cash. From the borrower’s point of view, the transaction consists of selling securities against cash, while agreeing in advance to buy back the securities at a predetermined price. The sold securities serve as collateral for the buyer (provider of cash) in the repo. Securities lending, the second largest category of SFTs, is primarily driven by market demand for specific securities, e.g. for short selling or settlement purposes. In this type of transaction, one counterparty lends securities for a fee against collateral in the form of cash or other securities given by another counterparty.

Under Article 29(3) of SFTR, the Commission is required to produce a report “on progress in international efforts to mitigate the risks associated with SFTs, including the FSB recommendations for haircuts on non-centrally cleared SFTs, and on the appropriateness of those recommendations for Union markets”.

In order to put the FSB recommendations in context and to respond to a commitment of the Commission in its Call for Evidence Communication, this report will also provide a brief assessment of European SFT markets.

As required under SFTR, the European Securities and Markets Authority (ESMA) produced a report, in cooperation with the European Banking Authority (EBA) and the European Systemic Risk Board (ESRB), assessing:

• whether the use of SFTs leads to the build-up of significant leverage that is not addressed by existing regulation;
• where appropriate, the options available to tackle such a build-up;
• whether further measures to reduce the pro-cyclicality of that leverage are required

The report concludes that to a large extent, the FSB recommendations on SFTs have been addressed in the EU through the adoption of SFTR and specific provisions in sectoral financial services legislation and guidelines. As such, there does not seem to be a need for further regulatory action at this stage.

As regards the cross-sector qualitative standards for the calculation of haircuts and the introduction of numerical haircut floors, an assessment of the need for and the scope of a potential regulatory action in this field should be based on comprehensive and detailed data on SFT markets which will be available once the SFTR reporting obligation becomes effective. Moreover, the current market dynamics reinforce the need for a certain degree of caution and robust evidence when reflecting on regulatory action implying quantitative requirements.

Progress at international level is comparable to the EU (i.e. in the early assessment phase) and no other region has taken a decision on regulatory action on haircut floors at this stage. If applicable, the introduction of numerical haircut floors should ideally happen in a globally coordinated manner to avoid compromising a level playing field or putting market participants in the ‘first-moving’ jurisdiction at a competitive disadvantage.

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