Banking » Are investment banks too complacent about SFTR?

Are investment banks too complacent about SFTR?

Banks need to invest in compliance for more regulatory initiatives, says Geoff Hutton, EMEA Regulatory Specialist at Luxoft, a digital strategy and software engineering firm.

Investment banking has seen an almost constant regulatory change in the decade since the financial crisis and the compliance burden on banks has soared. By and large, given the demands that governments and regulators have placed on it, the industry has coped well. Today, the sector is more tightly regulated but also better run, with more streamlined processes and more sophisticated technology as a result of its efforts to meet the challenge to comply.

Certainly, when it comes to transaction reporting, significant strides have been made to ensure compliance with previous regulations such as the Markets in Financial Instruments Directive (MiFID II) and EMIR (the European Market Infrastructure Regulation).

That said, past performance is not a reliable indicator of future results. New regulation can still present fresh challenges for the industry and we should guard against complacency. That is certainly the case with the EU’s new Securities Financing Transactions Regulation (SFTR), which comes into force next April. SFTR is part of the drive by the European Securities and Markets Authority (ESMA) to promote greater transparency in the financial system. A response to the Financial Stability Board’s work to improve oversight of the shadow banking system, SFTR requires banks and others to report all repurchase (repo) agreements, securities lending, and margin lending trades, to a repository the day after the trade.

Used to manage balance sheet liquidity (in the case of repos), or to allow equities businesses to trade in assets they do not own (securities lending), these transactions are often among the most operationally complex and varied undertaken by banks. Moreover, traders complete much of the activity by phone (or verbally across trading floors) and front-to-back office processing is generally less automated because many of the products are bespoke. To meet the reporting requirements, banks face significant challenges to capture, store, and verify data for these trades,?and to enable straight-through processing.

Clearly SFTR is the most demanding piece of transaction reporting regulation yet. Capturing the data required and putting in place the processes and technology to report efficiently is a considerable challenge. With little time left to meet it, are investment banks adequately prepared?

Misplaced confidence

It seems that many are feeling confident when it comes to their preparations for SFTR, but this overconfidence may be misplaced. Indeed, as a workout for a bank’s compliance function, SFTR is second only to Brexit. And yet, our latest Global Regulatory Report found that it was by no means clear that the industry is ready to meet the new regulation.

We asked Tier one, Tier two and Tier three investment banks about their preparedness for SFTR. Despite almost all (99%) senior compliance professionals responsible for implementing the regulation being confident they will meet the requirements, we found that 98% of these banks will be relying on systems and process infrastructure used for past regulations such as EMIR to comply.

Trade transaction reporting for other asset classes was partially addressed by EMIR and Dodd-Frank, before being extended by MiFID II. SFTR takes this on a step further to over-the-counter SFT business such as repos and securities-based lending – activities that, until now, have been mostly exempt. Our findings suggest that the industry’s confidence comes from banks’ experiences with previous transaction reporting requirements and existing infrastructures.

The experience of previous regulations – not just MiFID II but, more particularly, the European Market Infrastructure Regulation (EMIR) –could explain much of the bullishness of banks towards SFTR.  Some of the groundwork from these regulations will help firms to comply and there can be no doubt that the experience of MiFID II and EMIR has helped banks improve their systems and processes, prompting them to invest in infrastructure and straight-through processing for financial transactions.

Most have developed coherent regulatory reporting systems (supported by business processes) and control and assurance teams to cover the critical trade and transaction reporting regulations. Many are also taking advantage of improved technology, using data lakes5 and such-like to collect and provide access to the information they need for reporting. Other than for Tier One banks, solutions often take their lead from specialist third-party vendor platforms. All of this existing investment and technology will play a significant role when it comes to SFTR compliance.

However, SFTR presents a completely different set of challenges. For a start, even though SFTR is an EU regulation and data is required from European branches, all European-based activity – including that of non-EU firms – falls within its scope. Also, the necessary data is higher in both volume and complexity, and firms are facing a data deluge that their existing systems and processes (including those implemented to comply with EMIR) are ill-equipped to handle.

Furthermore, some firms will have been hoping for a delay in implementation. After all, the European Commission extended the implementation of MiFID II by a year. That’s not going to happen to SFTR, though. In March 2019, the legislation entered the Official Journal of the EU. So, from 12 April 2020, we will see the first SFTR transaction reports. Even allowing for a grace period in which regulators monitor the market, they will probably take the first actions against firms failing to report, by the end of that year.

As with EMIR and derivatives trading, in the long-run, greater trust and transparency in SFTs will increase the volume of trades in the market. And given that SFT trading across the industry is currently spreadsheet-based and relatively non-automated, if products and processes are standardised and optimised they can be scaled. Capturing the data required and putting in place the processes and technology to report efficiently will be a costly exercise which firms may not be prepared for.

Growing complexity

These issues were acknowledged by the banks. Indeed, 74% said that SFTR compliance will require a much more complex IT infrastructure than EMIR or MIFID. Furthermore, almost three quarters (72%) agreed that SFTR implementation will be more costly than EMIR or MIFID, with 30% saying the cost of hiring new talent will be the most expensive aspect.

Despite these gaps in preparation, fewer than half (48%) have conducted a cost benefit analysis of the regulations or set up a planning committee (46%), centralised their SFT reporting (39%) or hired a trade repository (TR) (26%). This delay, coupled with additional compliance burdens that have soared over the last decade and growing Brexit constraints, could mean banks having to devote a lot of ‘last minute’ time, resources and spend in order to meet the deadline.

With less than a year to go, banks need to start establishing their SFT activities, understand trigger events and report types, and decide how they will build or outsource their software solutions. By effectively implementing SFTR, firms not only have an opportunity to mitigate future risks, but could also realise the business benefits that this new regulation brings. Of course, it’s reasonable to assume that, ultimately, firms will do what is required to comply, even if doing so ends up being more complicated and expensive than envisaged. But our findings suggest that for many, mere compliance is the best they can hope for. The potential business benefits of SFTR may not be realised until much later.

And these benefits should not go unnoticed. When asked about the benefits of SFTR, we found that 78% of firms recognise that investment in compliance for regulatory initiatives such as SFTR makes their market position stronger and more resistant to new entrants. If done properly, SFTR implementation will also help to streamline in-house processes, improve the use and risk management of collateral, and ultimately boost the transparency of funding.

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