The Securities Financing Transactions Regulation

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1 The Securities Financing Transactions Regulation Introduction Key requirements Scope Reuse requirements UCITS and AIF disclosure requirements Consequences of noncompliance Implementation timetable Introduction The Council of the EU formally adopted the Securities Financing Transactions Regulation (SFTR) on 16 November 2015, which will form part of the EU s package of legislation targeted at reforming shadow banking and aims to improve transparency in the securities financing transactions (SFT) market. The SFTR is expected to be published in the Official Journal of the EU shortly and will enter into force 20 days after its publication. Set out below is an outline of the SFTR s scope, its requirements and the dates by which those requirements are to take effect. Given that the requirements relating to the reuse of collateral received are not only confined to SFTs, the SFTR will impact different business areas involving security and title transfer collateral arrangements, including those providing derivatives and prime brokerage services. Key requirements Key requirements imposed by the SFTR include: counterparties to an SFT having to (i) report the SFT s details to a trade repository upon its conclusion, modification and termination; and (ii) keep records of the SFT for at least five years following its termination; a party reusing financial instruments received under a collateral arrangement having to (i) first disclose the risks and consequences and obtain written consent; and (ii) only exercise its right to reuse in accordance with the collateral arrangement s terms and only with respect to financial instruments that have been transferred from the providing counterparty s account; and managers of undertakings for collective investment in transferable securities (UCITS) and alternative investment fund managers (AIFMs) having to disclose their use of SFTs and total return swaps to investors in their half-yearly and annual reports and in their pre-investment disclosures. Scope Scope of SFTs and Reuse SFTs comprise repurchase transactions, securities and commodities lending and borrowing transactions, buy/sell-back and sell/buy-back transactions and margin lending transactions. The inclusion of margin lending extends the scope of the SFTs to transactions beyond the scope of those traditionally considered as SFTs. Reuse refers to 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 title transfer or security collateral arrangement. Freshfields Bruckhaus Deringer LLP 1

2 Territorial scope The SFTR s territorial scope reaches beyond the EU. As well as applying to an EU entity that is party to an SFT (for the purpose of the ) or engaging in reuse (for the purpose of the reuse requirements), the SFTR applies to: an EU entity s non-eu branch that is party to an SFT or engaging in reuse; and a non-eu entity that is party to an SFT or engaging in reuse, if (i) the SFT is concluded or the reuse is effected by that non-eu entity s EU branch; or (ii) the reuse concerns financial instruments provided under a security or title transfer collateral arrangement by an EU counterparty or EU branch. Non-EU entities will, therefore, have to have systems in place to monitor which of the financial instruments that they intend to reuse have been provided by an EU counterparty or by an EU branch of a non-eu entity. Scope of entities Whilst there are additional obligations imposed specifically on UCITS managers and AIFMs to disclose information to investors on the use of SFTs and total return swaps, the SFT reporting and reuse requirements apply to both financial counterparties and non-financial counterparties. However, the SFT reporting and reuse requirements do not apply to certain counterparties, such as members of the European System of Central Banks, and there are certain exceptions for non-financial counterparties (as set out below). Similar to the reporting obligation imposed on counterparties to derivatives under the European Markets Infrastructure Regulation (EMIR), the SFTR imposes an obligation on both counterparties to an SFT to report details of the transaction to a trade repository within one working day of the transaction s conclusion, modification or termination. Parties required to report Although both counterparties have an obligation to report the details of an SFT, a financial counterparty is responsible for reporting the details on behalf of both counterparties where its counterparty is a non-financial counterparty which on its balance sheet date does not exceed at least two of the thresholds of: (i) a EUR 20,000,000 balance sheet total; (ii) a EUR 40,000,000 net turnover; and (iii) 250 employees on average during the financial year. Where a UCITS or an alternative investment fund (AIF) is the counterparty to an SFT, the UCITS manager or AIFM shall be responsible for reporting on behalf of the UCITS or AIF. Further, any counterparty subject to the reporting obligation may delegate the reporting. Details to be reported It is envisaged that the details of the SFT reports, which will vary for each type of SFT, will be consistent with those provided for derivatives under EMIR. The SFTR specifies the minimum information to be reported, which includes the parties to the SFT, the principal amount, the currency, the assets used as collateral, and whether the collateral is available for reuse. The European Securities and Markets Authority (ESMA) is required to submit to the European Commission within 12 months of the entry into force of the SFTR (i) draft regulatory technical standards (RTS) specifying the details to be reported; and (ii) draft implementing technical standards (ITS) specifying the format and frequency of the reports. As part of ESMA s consultation on these draft RTS and ITS, we would encourage clients to engage with ESMA so as to ensure that the reporting requirements are consistent with how transactions are actually carried out in operational practice, for instance where collateral is provided on a pooled basis. Record keeping Parties must keep records of any SFTs that they have concluded, modified or terminated for at least five years following the termination of the transaction. 2

3 Reuse requirements Disclosure and consent requirements A counterparty shall only be allowed to reuse financial instruments received under a title transfer or security collateral arrangement if it first: discloses to the providing party the risks and consequences of either (i) granting a right of use of collateral provided under a security collateral arrangement; or (ii) concluding a title transfer collateral arrangement; and obtains the providing party s express written consent to (i) a security collateral arrangement that includes a right of reuse; or (ii) the provision of collateral under a title transfer collateral arrangement. During the six months after the entry into force of the SFTR until the reuse requirements are to take effect, counterparties will need to adapt their collateral arrangements, including derivatives and SFT master agreements and prime brokerage agreements, to ensure that they comply with the new reuse requirements. Although under the current UK regime, prime brokers are required to disclose to clients the key risks arising from their assets being reused, the scope of disclosure required under the SFTR may be broader. Restrictions on the right of reuse A counterparty can only exercise its right to reuse if the reuse undertaken is in accordance with the original security collateral arrangement or title transfer collateral arrangement and if the financial instruments received under the arrangement are first transferred from the account of the providing counterparty. UCITS and AIF disclosure requirements UCITS management companies, UCITS investment companies and AIFMs must disclose certain specified information to investors about their use of SFTs and total return swaps. Half-yearly and annual reports The use of SFTs and total return swaps must be disclosed by (i) UCITS management and investment companies in their half-yearly and annual investor reports required under the UCITS IV Directive; and (ii) AIFMs in their annual investor report required under the AIFM Directive. ESMA is empowered to specify in draft RTS the detailed information to be disclosed, but the minimum information to be disclosed includes the amount of securities and commodities on loan as a proportion of total lendable assets and the amount of assets engaged in each type of SFT and total return swap expressed as an absolute amount and as a percentage of the fund s total assets under management. Pre-contractual disclosure In the UCITS prospectus required under the UCITS IV Directive and the AIF pre-investment disclosure required under the AIFM Directive, UCITS management or investment companies and AIFMs must specify which SFTs and total return swaps they are authorised to use and include a clear statement that those transactions are used. Examples of information that must be disclosed include a general description of the SFTs and total return swaps used and the maximum and expected proportion of assets under management that can be subject to those transactions. ESMA is empowered to provide draft RTS specifying further details to be disclosed. Consequences of non-compliance Member States must empower competent authorities to impose sanctions for at least breaches of the SFT reporting and reuse requirements, including a public statement of censure, the withdrawal of authorisation, a temporary ban against a person discharging managerial responsibilities and a fine up to a maximum of three times the amount of profit gained and loss avoided. However, a breach of the SFT reporting requirement will not affect the validity or enforceability of the SFT itself. 3

4 Implementation timetable The SFTR, including the requirement to keep records of any SFTs for at least five years following the transaction s termination, will enter into force 20 days after its publication in the Official Journal of the European Union, except that certain requirements are to take effect from a later date, as set out in the table below. Requirement Date by which in force Reuse requirements Counterparties to comply with requirements on reuse of collateral (e.g. to obtain express written consent and to disclose the risks and consequence) 6 months after the SFTR s entry into force UCITS/AIF disclosure requirements UCITS and AIFMs to disclose their use of SFTs and total return swaps in their halfyearly and annual reports (as applicable) UCITS and AIFMs to disclose their use of SFTs and total return swaps in their prospectus and pre-investment disclosure (as applicable) 12 months after the SFTR s entry into force 18 months after the SFTR s entry into force for AIFs and UCITs that are already constituted before the SFTR s entry into force Investment firms and credit institutions to report SFTs to a trade depository Central securities depositories and central counterparties to report SFTs to a trade depository Insurance/reinsurance undertakings, UCITS/UCITS managers, AIFs/AIFMs and institutions for occupational retirement provision to report SFTs to a trade depository Non-financial counterparties to report SFTs to a trade depository 12 months after the entry into force of the SFT 15 months after the entry into force of the SFT 18 months after the entry into force of the SFT 21 months after the entry into force of the SFT Application of to existing SFTs The obligation to report an SFT to a trade repository will apply to an SFT existing before the date on which the obligation takes effect (as set out in the table above) if (i) the remaining maturity of the SFT exceeds 180 days; or (ii) the SFT has an open maturity and remains outstanding 180 days after that date. Those SFTs must be reported within 190 days of the relevant date of application. Application of reuse requirements to existing collateral arrangements The requirements relating to the reuse of collateral will apply to collateral arrangements existing on the date that the requirements enter into force, that is six months after the SFTR s entry into force. 4

5 For more information please contact: Michael Raffan T E michael.raffan@freshfields.com David Rouch T E david.rouch@freshfields.com Mark Kalderon T E mark.kalderon@freshfields.com James Smethurst T E james.smethurst@freshfields.com Alexander Glos Partner, Germany T E alexander.glos@freshfields.com Raffaele Lener Partner, Italy T E raffaele.lener@freshfields.com Steven Lightstone Associate, UK T E steven.lightstone@freshfields.com freshfields.com This material is provided by the international law firm Freshfields Bruckhaus Deringer LLP (a limited liability partnership organised under the law of England and Wales) (the UK LLP) and the offices and associated entities of the UK LLP practising under the Freshfields Bruckhaus Deringer name in a number of jurisdictions, and Freshfields Bruckhaus Deringer US LLP, together referred to in the material as Freshfields. For regulatory information please refer to The UK LLP has offices or associated entities in Austria, Bahrain, Belgium, China, England, France, Germany, Hong Kong, Italy, Japan, the Netherlands, Russia, Singapore, Spain, the United Arab Emirates and Vietnam. Freshfields Bruckhaus Deringer US LLP has offices in New York City and Washington DC. This material is for general information only and is not intended to provide legal advice. Freshfields Bruckhaus Deringer LLP, November 2015, [dtp]